Value Line Convertibles Survey’s Third Quarter Performance
Investors faced economic and political uncertainty throughout the third quarter, causing many small investors to shun stocks and favor bonds and gold. After the August lull, however, the month of September saw all of the major stock market averages post their best monthly performance so far this year. In fact, the Dow Jones Industrial Average gained 7.7%, while the S&P 500 and the Russell 2000 gained 8.8% and 12.3%, respectively. For the September quarter, the averages also had impressive returns. The Dow gained 10.8%; the S&P 500, 11.2%; and the Russell 2000, 11.5%. These handsome gains, however, just compensated for earlier setbacks, bringing year-to-date totals to 3.8%, 2.8%, and 8.6%, respectively. (Note: Our third quarter ended October 1st.)
Although convertibles tend to lag their underlying stocks in an upbeat market, they turned in their best monthly performance so far this year. Our All Convertibles Total Return Index gained 5.0%, and our Especially Recommended portfolio scored a 4.5% gain. For the quarter, the indexes were up 7.9% and 8.1%, respectively.
Especially Recommended convertibles are categorized into four different risk groups based on Relative Volatility--an internal indicator of the level of risk in holding a convertible vis-à-vis its underlying common stock. The relative volatility of the stock is a measure of how risky that stock is in relation to the median stock in The Value Line Investment Survey universe of approximately 1,700 stocks, and some 1,800 stocks in The Value Line Investment Survey Small and MidCap Edition. Our High Risk group consists of warrants only, and has the highest profit potential. The Above Average Volatility group carries convertibles with Relative Volatility of 95% and above, with above-average profit potential. The Modest Volatility (moderate profit potential) group has convertibles whose Relative Volatility is between 65% and 90%, and the Low Volatility (modest profit potential) group has convertibles whose Relative Volatility is 60% and below.
Group performances were mixed in the third quarter. For the period, the High Risk group with three warrants had a 140.7% gain, thanks to the fast-rising Caliper Life Sciences 2011 warrant. The Above-Average Volatility group posted a gain of 13.5%, the Moderate Volatility group 6.2%, and the Low Volatility group a gain of 7.9%. For the nine-month period (ended October 1, 2010), the groups returned 25.9%, 3.5%, and 11.1%, respectively.
Our Especially Recommended Rank 1 convertibles portfolio (including warrants) gained 10.7% for the short period, and 13.4% over the nine months span. Without the warrants, the gains were 7.8% and 10.8%, respectively. Meanwhile, all convertibles ranked 1 in our survey returned 9.3% for the quarter, and 15.2% for the nine months. By groups, the Above-Average Profit Potential group rose 8.7%, the Low Profit Potential group gained 8.1%, and the Moderate Profit Potential group lost 1.8%. The sole rank 1 warrant soared 173.9%.
Although convertibles are defensive in nature, an upward trending equity market can make these instruments just as aggressive as their underlying common stocks, especially if the common is trading above the conversion trigger price. Bear in mind, however, that these results serve only as an indication of how investors would fare following our recommendations at the quoted trading levels. As we depend on outside sources for quotes on these convertibles, these prices may not be available when investors act on our recommendations. Our pricing dates lag our publication dates. Moreover, commission costs and other expenses are not taken into consideration for our calculations.