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The Value Line Convertibles objective group covers mutual funds that invest the majority of their assets in an unusual and relatively obscure asset class—convertible bonds and convertible preferred stocks. Indeed, 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 portfolio at competitive prices.

The convertible 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 good performer relative to the broader market, as measured by the Barclays Aggregate Bond Index. For the 10-year period ended May 31, 2013, the group had an annualized return of 6.5%, while the Barclays Aggregate Bond Index reported an annualized gain of 4.6%. Over the trailing five and three-year periods through May 31, 2013, the group had gains of 4.9% and 10.0%, respectively, while the Index reported annualized gains of 5.3% and 4.6% respectively. During the past year, the Convertible objective group reported a gain of 19.6%, compared with a gain of 0.9% for the Index. Year to date through May 31, 2013, the Convertible objective group outperformed the Barclays Aggregate Bond Index. It reported a return of 10.4% compared with a loss of 0.9% 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. 

Fund Name: AllianzGI Convertible Fund A
Ticker: ANZAX
Year-to-Date Return: 13.16%
Benchmark: BofA Merrill Lynch All Convertible Index
Objective: The Fund seeks maximum total return, consisting of capital appreciation and current income.
Investment Strategy:
• Invests at least 80% of its net assets in convertible securities (which include corporate bonds, debentures, notes or preferred stocks and their hybrids).
• May invest in securities of any market capitalization or credit quality, and may from time to time invest a significant amount of its assets in securities of smaller companies.
• Invests up to 20% of its net assets in nonconvertible debt securities rated below investment grade or unrated and determined to be of similar quality.
• May also invest in securities issued by the US government and its agencies and instrumentalities.

Fund Name: Columbia Convertible Securities Fund A
Ticker: PACIX
Investment Advisor: Columbia Management Investment Advisors, LLC
Year-to-Date Return: 12.78%
Benchmark: BofA Merrill Lynch All Convertibles All Qualities Index
Objective: The Fund seeks total return, consisting of capital appreciation and current income.
Investment Strategy:
• Invests at least 80% of its net assets in convertible securities.
• May invest 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 convertible securities are not investment grade-rated.
• Convertible securities rated below investment grade may be referred to as junk bonds.
• May also invest in other equity securities. 

Fund Name: Lord Abbett Convertible Fund A
Ticker: LACFX
Investment Advisor: Lord, Abbett & Co. LLC
Year-to-Date Return: 11.63%
Benchmark: BofA Merrill Lynch All Convertible Index
Objective: The Fund seeks current income and the opportunity for capital appreciation to produce a high total return.
Investment Strategy:
• Invests principally in US equity securities and select fixed income securities and foreign (including emerging market) securities.
• Invests in equity securities consisting principally of common stocks, preferred stocks, and equity interests in trusts (including real estate investment trusts), partnerships, joint ventures, limited liability companies and similar enterprises.
• Invests in fixed income securities consisting principally of high yield debt securities, investment grade debt securities, mortgage-related and other asset-backed securities, US government securities, convertible securities, bank loans, investments, and cash equivalents.
• May invest up to 100% of their assets in fixed income securities that are below investment grade.
• May also invest directly in any type of derivatives consisting principally of futures, forwards, options, and swaps.

In the table below, we have listed 10 top-performing funds through May 31, 2013 from our Fund Advisor database. 

  

10 Top Convertible Funds Performance 

 

Fund Name 

Ticker 

% Year-to-date 

Total Return 

% 1 Month 

Total 

Return 

% 3  

Month 

Total 

Return 

% 6 Month 

Total  

Return 

% 5 Year 

Total 

Return 

Annualized 

Fidelity Convertible Securities Fund 

FCVSX 

13.38 

4.36 

8.73 

17.75 

3.85 

AllianzGI Convertible Fund A 

ANZAX 

13.16 

3.13 

7.50 

15.36 

  

Fidelity Adv Convertible Securities Fund A 

FACVX 

13.26 

4.34 

8.63 

17.60 

  

Columbia Convertible Securities Fund A  

PACIX 

12.78 

3.06 

7.81 

14.69 

5.08 

Miller Convertible Fund  

MCFAX 

11.15 

2.81 

6.69 

13.63 

6.34 

Invesco Convertible Securities Trust Fund A 

CNSAX 

11.61 

3.12 

7.20 

13.88 

7.72 

Lord Abbett Convertible Fund A  

LACFX 

11.63 

2.90 

7.77 

13.57 

4.22 

Franklin Convertible Securities Fund A 

FISCX 

4.28 

-0.11 

8.30 

13.02 

4.04 

Calamos Convertible Fund A 

CCVIX 

11.27 

3.57 

6.84 

13.90 

6.32 

Putnam Convertible Securities Fund A 

PCONX 

10.73 

2.41 

6.62 

13.01 

5.47 

Convertible  Objective Group 

  

10.38 

2.57 

6.23 

12.17 

4.87 

  

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