The Value Line Convertibles objective group covers mutual funds that invest in an unusual and relatively obscure asset class—convertible bonds and convertible preferred stocks. Convertibles are a mixture of a bond (or a preferred stock) and a warrant to purchase common stock in the issuing company. This creates a hybrid security with both bond-like and equity-like features.

At times, a convertible bond can trade like a regular bond, based on the underlying company’s ability to make interest payments, interest rates, and other bond-specific factors. At other times, however, convertibles can trade more like stocks—typically when the value of the conversion feature (the warrant) is greater than the value of the bond. The end result is that convertibles often provide downside protection because of the bond component of the securities, but also upside participation if the stock price of the issuing company rises (though this participation is usually muted relative to a direct equity purchase).

Mutual funds are one of the best ways for individual investors to participate in the convertible market because of the illiquid nature of many convertible securities. Also, small sales and purchases are often subject to large markups and trading costs, further reducing the benefit of direct purchase. Indeed, it would be difficult for an individual investor to cost effectively acquire a diversified convertible portfolio at competitive prices.

The convertibles market is small relative to the bond market and the stock market. Moreover, many issuing companies in this space are financially weak compared to the broader markets. Thus, managers here are generally selective in their portfolio construction. At the end of the day, the funds can be rather eclectic, and each needs to be reviewed carefully. Some managers tend toward more-aggressive, lower-quality holdings, while others prefer higher-quality investments. And these tendencies are subject to change based on market conditions.

Over the long term, the Convertible objective group has been a weak performer relative to the broader market, as measured by the Barclays Aggregate Bond Index. For the 10-year period ended May 31, 2012, the group had an annualized return of 4.9%, while the Barclays Aggregate Bond Index reported an annualized gain of 5.6%. Over the trailing five and three-year periods through May 31, 2012, the group had gains of 1.1% and 10.8%, respectively, while the Index reported annualized gains of 6.6% and 7.1%, respectively. During the past year, the Convertible objective group reported a loss of 9.3%, compared with a gain of 7.1% for the Index. Year to date through May 31, 2012, the Convertible objective group underperformed the Barclays Aggregate Bond Index.  It reported a return of 1.9% compared with a gain of 2.3% for the Index.  

The group has a better-than-average Risk Rank of 2, indicating that funds in this group might appeal to more conservative investors. 

One fund with a relatively strong year-to-date return through May 31, 2012 is Fidelity Convertible Securities Fund (FCVSX). The fund seeks a high level of total return through a combination of current income and capital appreciation. 

The fund invests at least 80% of assets in convertible securities, which are often lower-quality debt securities and perform more like a stock when the underlying share price is high, and more like a bond when the underlying share price is low. Management potentially invests in other types of securities, including common stocks. When selecting investments, management analyzes each issues' financial condition and industry position, as well as the general market and economic situation. 

Another fund that had a year-to-date total return through May 31, 2012 that outperformed its peers is Columbia Convertible Securities Fund A (PACIX). The fund seeks total return, consisting of capital appreciation and current income. 

Under normal circumstances, it invests at least 80% of its net assets in convertible securities, up to 15% of its total assets in Eurodollar convertible securities, and up to an additional 20% of its total assets in foreign securities. Most convertibles are not investment grade-rated.

Columbia Management Investment Advisers, LLC, the fund’s investment adviser, looks for opportunities to participate in the potential growth of underlying common stocks, while seeking to earn income that is generally higher than the income those stocks provide. The adviser considers a number of factors in identifying investment opportunities and constructing the fund’s portfolio, including, among others:

■ overall economic and market conditions

■ the financial condition and management of a company, including its competitive position, the quality of its balance sheet and earnings, its future prospects, and the potential for growth and stock price appreciation

■ the characteristics of the security, including its conversion feature.

The adviser tries to limit conversion costs and generally sells securities when they take on the trading characteristics of the underlying common stock. The adviser also may convert securities to common shares when it believes it’s appropriate to do so. 

A third fund with a good relative year-to-date return for 2012 is Invesco Convertible Securities Fund A (CNSAX). The Fund’s investment objective is a high level of total return on its assets. 

The fund normally invests at least 80% of its net assets (plus any borrowings for investment purposes) in convertible securities. In complying with the 80% investment requirement, the fund may include synthetic securities that have economic characteristics similar to the fund’s direct investments.

The fund’s convertible securities may include lower rated fixed-income securities commonly known as junk bonds. The convertible securities also may include exchangeable and synthetic convertible securities. Unlike traditional convertible securities whose conversion values are based on the common stock of the issuer of the convertible security, synthetic and exchangeable convertible securities are preferred stocks or debt obligations of an issuer which are combined with an equity component whose conversion value is based on the value of the common stock of a different issuer or a particular benchmark (which may include a foreign issuer or basket of foreign stocks, or a company whose stock is not yet publicly traded).  

The fund can also utilize derivative instruments, including forward foreign currency contracts to mitigate the risk of foreign currency exposure. A forward foreign currency contract is an agreement between parties to exchange a specified amount of currency at a specified future time at a specified rate. Forward foreign currency contracts are used to protect against uncertainty in the level of future foreign currency exchange rates. The fund will use these contracts to hedge against adverse movements in the foreign currencies in which portfolio securities are denominated. The fund may also invest in real estate investment trusts (REITs).  

The remaining 20% of the fund’s assets may be invested in common stocks directly, non-convertible preferred stock, non-convertible fixed-income securities, and/or foreign securities. The foreign securities may include non-US dollar denominated securities and depositary receipts. The fund’s fixed-income investments may include zero coupon securities, which are purchased at a discount and generally accrue interest, but make no payment until maturity.

In the table below, we have listed 10 top-performing funds through May 31, 2012 that we follow in our Fund Advisor database.

10 Top Convertible Funds Performance


Fund Name


% Year-to-date

Total Return

% 1 Month



% 3




% 6 Month



% 5 Year




Fidelity Convertible Securities







Columbia Convertible Securities A







Invesco Convertible Securities A







Vanguard Convertible Securities







Putnam Convertible Income- Growth Fund A







Franklin Convertible Securities A







Lord Abbett Convertible Fund A  







PIMCO Convertible Fund A







Victory Investment Grade Convertible A







Miller  Convertible Fund A







Convertible  Objective Group








At the time of this article's writing, the authors did not have positions in any of the funds mentioned.