Stocks performed solidly in the third quarter, as the Federal Reserve announced more stimulus measures for the U.S. economy, and efforts to ease the crisis in the euro zone were stepped up. The uptick in stocks
augured well for convertibles
. Premiums over conversion
value shrank somewhat, allowing for greater participation
in the advances
of the underlying common stocks
Equity losses among convertibles
were cushioned by interest or dividend income
and investment value
. The Value Line Convertibles Survey All Convertibles Total Return Index lost 0.6%, while the Recommended Convertibles, as a group, suffered a 4.1% drop.
The exodus of capital from safer investments into more-risky global assets curtailed the value of convertibles in the first quarter. While some lower-volatility convertibles had good performances, stocks underlying our recommended convertibles outpaced the debt issues 18% to 8.6%
Despite the uncertainties of global economic conditions last year—a downgrade in the U.S. credit rating, political gridlock in Washington, Europe’s unending debt crisis, as well as declining home prices, and higher oil quotations--the Dow Jones Industrial Average managed to end the year up 5.6%, thanks to a 12% increase in the fourth quarter.
With most equity markets in a state of flux, investors are seeking safer havens, buying up corporate bonds and government securities. Some investors have found buying opportunities among downtrodden securities, convertibles included.
The exceptional leverage provided by warrants makes them ideal candidates for hedging. A warrant hedge consists of a long position in a warrant and a short position in the underlying common stock.
One of the issues common-stock investors face when waiting for a downtrodden issue to rebound is that their capital is tied up and unavailable for other, possibly more productive, uses. However, financial instruments, such as warrants, can help mitigate this problem. Indeed, they may be a good option for long-term investors that are bullish on battered stocks or sectors, such as financials.
Our recommended convertibles posted a 6.9% gain for the first quarter of 2011, beating most major indicies.
Greatbatch, Inc. (GB), the pioneer in pacemaker devices is an interesting investment in the healthcare/medical devices sector, as medical practitioners implant these devices almost on a daily basis. But because failure in any of these devices can send shock waves throughout the industry, investors can avoid volatility by investing in Greatbatch’s 2.25% convertible notes due 2013.
The volatile equity markets have caused investors to again rethink their investment strategies. As the markets gyrate, investors often run to seek safer havens for their investment dollars. One area that affords income, safety, and participation in the equity markets, all at once, is convertible securities. This week our recommendations include Buy, Sell, and Hold advice about convertibles issued by Orbital Sciences Corp., Archer-Daniels-Midland Company, Mentor Graphics Corp., and NuVasive, Inc.