Editor's note: This column originally appeared in The Save Safe Plan, our long-term investing newsletter, which includes Dagen McDowell's personal finance columns and David Peltier's Save Safe model portfolio of dividend-producing stocks. If you'd like to receive a free trial of The Save Safe Plan, click here.
If you're looking for a fund with a fat yield, it's hard to miss the
This fund's payout of almost 6% is startling when compared with the 2% yield on the average U.S. stock and bond fund.
But its yield isn't the only unusual thing about this fund. The strategy behind that number is equally unique. The fund has more than half its money in convertible bonds, securities that can be exchanged for stock in a company at a prestated price. Plus, it has a solid long-term record and a below-average expense ratio to boot.
Manager Charles "Chip" Carlson explains.
First, what does this fund invest in?
We do have a distinctive approach. Right now we have 41% in stocks, 52% in convertible bonds and 7% in cash. We've always taken a balanced approach. There have been a lot of opportunities in convertibles and we've focused on "busted convertibles," which have been increasingly attractive.
With the drop in market, the stocks of some companies have fallen and "busted" their convertibles. The stocks are trading below the conversion prices in those bonds, making those bonds less attractive. But these "busted" convertibles pay more interest than some fixed-income securities or those that have value because you can convert into common stock at an attractive price.
As long as the company makes the coupon payments and pays off those bonds at maturity, the return is achieved regardless of what happens in stock market and direction of interest rates. That's if you do your analysis correctly. With an undervalued common stock, if no one agrees with your analysis, you'll never make money, because the stock will stay undervalued.
How Greenspring Stacks Up
We've always focused on inefficiently priced or under-followed securities. We're not part of a big fund family and we're not pigeonholed into one style. We try to find securities that are underappreciated or undervalued. Busted convertibles flowed out of that mandate.
What's the risk profile between convertibles and stocks?
Convertible bonds are a hybrid security between a stock and bond. They're generally less volatile than common stocks and pay higher current income.
Busted convertibles, on the other hand, are a lot less sensitive to underlying common stock because they're busted or the conversion price in the bond is higher than where the stock is currently trading. The old-fashioned convertible buyer, who wants to convert these securities into common stock, wouldn't be attracted to busted convertibles. But they can offer attractive current income or yields to maturity. And we try to narrow our focus to those companies with strong balance sheets.
Springing for Green
Are convertibles hard to buy or invest in if you're an individual?
Yes. It's very difficult. Almost all convertibles trade over the counter -- very few are listed on an exchange. There's little pricing information available to individuals and the vast majority of trades in increments of 1 million. They're difficult to trade directly.
What about some of the "busted" convertibles the fund owns right now?
Because of what happened in the stock market in the last two to three years, there are a lot of opportunities in tech companies. We look at those backed by companies with very strong balance sheets. About half to two-thirds of the companies we own currently have more cash than total debt on their balance sheets. If they wanted to, they could write checks and pay off all their debt.
, a contractor known for building electric power plants and petrochemical plants. It's profitable, has positive free cash flow and has almost as much cash as debt. We recently bought its convertible bonds, which have 11.5% yield to put -- when the bond can be "put" back to the issuer which is 15 months from now. That's about a 12% return for the next 15 months. To me that kind of return will be achieved regardless of what happens in stock market or direction of interest rate.
If the Bush proposal to eliminate the tax on dividends passes, will convertibles lose their appeal?
If it goes through, there would be more competition from higher-yielding common stocks.
You also buy value stocks. What about that part of the portfolio?
We've enjoyed volatility. From the end of December through the first few weeks of January, stocks were richer than we wanted to pay. But as the market turned down we started buying.
Federal Signal Corp.
It's in different niches but it makes fire trucks, rescue equipment and street sweepers among other things. The company has a high current dividend yield of between 4% and 5%. The top line is doing OK, but earnings have been under pressure. There's been margin pressure in its fire rescue equipment business. But the company should improve efficiency.
In keeping with TSC's editorial policy, Dagen McDowell doesn't own or short individual stocks, nor does she invest in hedge funds or other private investment partnerships. Dagen welcomes your questions and comments, and invites you to send them to
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