Companies like Peloton offer high-yielding convertible bonds.
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Convertible bonds are off to a strong start this year after a tough 2022, and the gains could continue if growth stocks maintain their early-year momentum.
The
SPDR Bloomberg Convertible Securities
exchange-traded fund (ticker: CWB), at around $68, has returned 5.5% this month after declining 21% in 2022 (including dividends). The $4 billion ETF yields 2%, in line with the yield in the $235 billion market, which is tilted to growth companies.
“There’s a good balance between downside protection and upside if the markets rally,” says Howard Needle, a portfolio manager at Wellesley Asset Management, a convertibles specialist that runs the Miller Convertible Bond fund (MCIFX).
Convertible bonds are hybrid securities that pay a fixed interest rate and allow investors to exchange the debt for the issuing company’s shares if the stock price appreciates.
Investors can play the market through mutual funds, ETFs, or individual securities. In the past six months, Barron’s has highlighted the opportunity in high-yielding convertibles with yields of 8% or more that offer a good alternative to the issuers’ common shares.
These include converts from
Redfin
(RDFN),
Coinbase Global
(COIN),
Microstrategy
(MSTR),
Peloton Interactive
(PTON), Lucid Group (LCID), and
DraftKings
(DKNG), some of which have yields to maturity in the double-digits. For instance, Redfin’s zero-coupon convertible due in 2025 trades at 64 cents on the dollar and yields 17%. Microstrategy’s zero-coupon issue maturing in 2027 trades at 44 cents and has a 21% yield to maturity.
Many of the deeply discounted converts have advanced recently, but still offer ample yields. It can be tough for individual investors to buy them, however, since they trade in an over-the-counter market. Prices can be found on the FINRA market data website.
Full-service brokers with convertible trading desks offer the best access to these bonds. One reason for still-depressed prices in many converts is that they often carry little or no current yield. Many convert buyers want income. In addition, many converts have no credit ratings and likely would be junk-rated if they got them.
Looking at other high-yielding converts, Coinbase’s 0.5% issue maturing in 2026 trades at 67 cents on the dollar and yields 13%. Lucid’s 1.25% due in 2026 trades at 53 for an 18% yield. DraftKings’ zero-coupon maturing in 2028 trades at 65 for and 8% yield, and Peloton’s zero-coupon due in 2026 trades at 76 for a 9% yield.
The nice feature of these convertibles relative to the stocks is that investors stand to do well if the companies merely survive, barring debt restructurings. That’s a lower bar than for the stocks.
Michael Youngworth, a convertibles strategist at BofA Securities, has pointed out two attractive aspects of convertibles: They often are the only debt of the issuing company and the low—or zero—rates means little interest expense.
In addition, their short maturities—within five years—put pressure on management to find ways to pay off the bonds; refinancing and equity issuance are options.
Needle is partial to the higher-quality
Ford Motor
(F) zero-coupon due in 2026, trading around par.
Issuance is starting to pick up this year after new convertible sales in 2022 reached a mere $34 billion, down more 50% from the 2021 volume.
Live Nation Entertainment
(LYV) recently sold $1 billion of 3.125% converts that were well received by investors and now trade at a premium to their face value.
The market performance last year was poor, when converts didn’t live up to their billing of protecting investors in down markets. That reflected higher interest rates, a selloff in growth stocks, and wider credit spreads. All these negatives have reversed in 2023, and if those trends continue, it should be a good year for convertibles.
Write to Andrew Bary at andrew.bary@barrons.com
Credit: marketwatch.com