Rising interest rates could do severe damage to many corporate bond and equity closed-end funds that employ significant leverage. However, convertible bond closed-end funds have historically fared well when rates climb, and will likely so do again, said Tracy Maitland, chief investment officer at Advent Capital.
"If rates go back up, that means that the Federal Reserve believes we are in a stable to improving economy, and if that's the case, that would imply higher corporate profits and therefore higher stock prices and stable to improving credit spreads," said Maitland, adding that better spreads and rising stock prices are a "winning combination" for convertible bond funds.
Maitland runs the Advent Claymore Convertible Securities and Income Fund(AVK) - Get Report , which has seen its stock price drop 14% so far in 2015. The fund's net asset value is down 1.5% with reinvested dividends. The fund trades at a 17.5% discount to its NAV, and sports a dividend yield of 8%.
The trailing six-month average discount for the fund is 13.3%, while the three-year average discount is 9%, according to Morningstar. The fund's NAV has jumped 6% in the past month as the S&P has bounced back 10%.
"The idea is to capture the majority of the upside of the underlying equity market while only suffering a portion of the risk," said Maitland. "I think that's what happened in the last four weeks or so."
Maitland said convertibles are an overlooked asset class and more investors should include convertible bond funds in their portfolios. The key benefit of convertibles, according to Maitland, is that investors get "paid to wait."
"If you buy a convertible bond and it matures in five years, you get to collect a nice yield, and if the stock goes up you get to participate, and if the stock goes down, you've got your yield and a lot of your principle back," said Maitland.