When the conversion price is reached does the fund buy the equity and keep it or does it sell it on the market and use the proceeds to buy more bonds?
If my understanding is correct would you not be better off buying pure equities if you expect the markets to rise and a pure bond bond if you think markets are going to decline? So I am left with the question: "What is the value proposition of a convertible bond fund?"
Appreciate your insight.
Paul F.
We think your understanding here catches a lot of the key points. Convertibles are on the higher risk side of the fixed income spectrum and are a hybrid between stocks and bonds. Typically, they pay a higher yield because of that risk.
The ETF would typically sell their bond holdings prior to conversion opposed taking ownership of the underlying.
On the value proposition, they are in a bit of a strange spot, as they don't offer the same safety of more traditional fixed income and lower upside than straight equities. It would be a diversifier in a portfolio while offering a bit more upside to an income focused investor that might lean a bit more conservative. We think they can have a place in a portfolio but might not view it as a 'core' allocation.