A lot of investors fed up with the volatility in tech stocks are turning to something called a convertible bond. Until now, that usually meant buying a mutual fund that invests in convertible bonds. And for good reason. Convertibles can be tough to find, and even tougher to evaluate. Hence the need for professional help. (See a recent story on
convertible bond funds.)
Now a couple of Web sites come with online tools that let you analyze convertibles just like a pro. Plus, you'll find sites on the Web that can help you screen (that is search) for individual convertible issues or funds.
So what are convertible bonds and why are they so tough to figure out? Think of a convertible -- some people call them converts -- as a hybrid between a bond and a stock. Buy a convertible issued by, say,
and you get a fixed income stream, just as you would with any bond. But you also receive the right to convert your bond into a fixed number of shares of the company's stock.
It's the conversion feature that tech investors like -- even though new convert issues typically sell at a premium to the price of their underlying stock. Here's a simplified example: Say you pay $1,000 for XYZ Corp.'s bond. Ownership of the bond gives you the right to convert it to 20 shares of XYZ's stock. Suppose XYZ's shares are selling for $30 each. Multiply $30 by 20 and you get $600. You're paying a premium of $400.
Of course, the bond's yield helps offset whatever premium you pay, though because of the conversion feature, yields on convertible bonds are usually lower than they would be with ordinary bonds. Then again, if you simply held the stock (assuming it paid no dividends), you'd receive nothing.
But you're hoping the stock will appreciate. If it does, the bond should trade up as well. In fact, if XYX's shares rise to $50 or above, the bond becomes in the money ($50 per share x 20 shares = $1,000). From that point on, your convert will often rise in tandem with the stock price. You can either sell at a profit, or wait until the convert appreciates further.
Likewise, if the stock declines, the convert is apt to decline, too. But here's the good part: It probably won't decline as rapidly as the stock. That's because the convert, like an option, incorporates some time value in its pricing. There's always a chance the stock will rise again between now and the time the bond expires or it is called.
See how converts can give you some protection against the wild price swings in the tech sector? You receive the yield regardless of what happens to the stock. Plus, there's the upside potential if the stock rises.
Of course, there are nuances with converts that can easily trip you up. For example, converts are usually callable -- that is, the issuing company may exercise its option to buy back the bonds. This can happen if the stock appreciates to a certain point or after a set period of time. (For a complete explanation, see
series "Converts - the Best of Both Worlds?",
part 2 and
Also, you're juggling two dissimilar variables when you invest in converts: the interest-rate climate and the market climate for the underlying stock. That can make it tough to predict your potential return if the stock rises -- or your downside risk if the bond's called out early.
Here's where the Web comes to your rescue. Head over to
www.numa.com), operated by the U.K.-based
Numa Financial Systems
. The site contains an online calculator that lets you deconstruct any convert you're considering. Enter information like the bond's maturity, its coupon rate, and the underlying stock price (the site explains these terms as you go along). Click calculate, and you'll find out the bond's long-term yield potential. Not bad. And did I mention the site is free?
If you're really serious about converts, and you're up for paying a $10-per-month or higher subscription, then go to
www.convertbond.com). Recently launched by
Morgan Stanley Dean Witter
, there's a two-week free sign-up. The site lets you locate promising converts in several ways. First, a daily email newsletter lists new convert issues. Alternatively, if you're tracking certain companies, simply enter their ticker symbols, and you'll pull up a list of converts they've issued along with current prices and analyses. Finally, the site publishes the
MSDW U.S. 225 Convertible
index tracking the performance of the largest 225 convertible issues (ranked by market value). As of Feb. 21, the index was up 7.48%, year to date.
www.etrade.com) Bond Center contains a search tool that lets you ferret out convertibles that meet the criteria you select, such as S&P rating, callable date, current yield and so on. (From the E*Trade home page, go to "Bonds," then "Research Bonds" then click on "Advanced Research.")
Then again, maybe you'd rather have someone manage your convert portfolio for you. Morgan Stanley Dean Witter (
Solomon Smith Barney
www.agedwards.com) are three name-brand brokers that provide custom management of convertible bond portfolios through Los Angeles based
Forley Revy Investment
. Account minimums for these services range from $100,000 to $150,000.
If you don't have that kind of cash but still want a portfolio of converts, try a convert mutual fund. Using
www.quicken.com) you can pull up a
list of the 25 top-performing convert funds.
Whether you go with a fund or work your own portfolio, there's good evidence that converts can offer a safer passage through choppy markets. A
study of technology convertibles going back to 1995 showed they provided 70% of the upside returns of their underlying stocks. Plus, convertibles suffered smaller losses in all but one of the months during that period in which tech stocks declined.
Mark Ingebretsen is editor-at-large with
Online Investor magazine and a consultant to a major insurance company. He has written for a wide variety of business and financial publications. Currently he holds no positions in the stocks of companies mentioned in this column. While Ingebretsen cannot provide investment advice or recommendations, he welcomes your feedback at