Why There’s Just One Convertible Bond Fund You Should Hold Now

By Andrey Dashkov

It might as well be July in San Francisco. There’s fog about why any investor would want to hold convertible bonds in her portfolio, and I’m here to clear that fog away. Their yields aren’t high, their credit ratings often look shaky, and the bonds themselves are quite hard to understand due to their hybrid nature and built in options.

The answer, in short, is diversification.

As a rule of thumb, convertibles provide two-thirds of the upside of common stock with one-third of the downside. The first part of this equation sounds pretty good, but we’ll ignore it. Individual investors can’t cherry-pick a convertible to suit their fancy. Even if a good one is available, you’d have to pay dearly for it in commissions. This is a market for asset managers and hedge funds with pockets millions of dollars deep.

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That said, there are convertible security funds available for individuals. But buying funds means fund managers select the bonds, which diminishes the upside potential we’d have if we picked the best of the best ourselves. Plus, there are fees.

Since realizing the full upside of convertibles poses a lot of challenges for individual investors let’s focus on the one third downside: that convertible bonds may be less volatile than their stock or bond counterparts. Take a look at this chart.

The chart shows that from December 2003 to December 2013 convertible bonds were more than 2 percentage points less volatile than stocks, represented by the S&P 500 index. Adding convertibles to a portfolio of stocks lowered the volatility of the overall portfolio too.

Convertibles are less skittish than stocks on the downside because of the bond component convertibles have: the stream of coupon payments and the principal repayment at maturity. Although convertibles’ coupons tend to be lower than those of straight out bonds, they are a desirable feature when the going gets tough. In other words, convertibles have a floor that the bond’s price won’t fall through absent a default like event.

The one and only convertible bond fund my team holds in its portfolio, we hold for downside protection and diversification. The fund has a robust portfolio of 97 investments, including 37% allocated to the technology sector and 17% to consumer non cyclical. It has a third of its holdings in investment grade bonds, which is particularly important because a lot of convertible securities have junk-bond status.

In short, this fund is far better than your average convertible fund. That’s why we recommended it, and it’s why it’s earned over 20% since. Its solid portfolio and a growing stock market helped the fund deliver excellent results for a “boring” investment. We recommended it when interest rates were rising because we liked where it was going: up, supported by the increase in the S&P 500.

Even if the stock market goes down convertibles will not fall too far (remember the one third downside rule). This is the stability we sought in this investment.

We like our pick, but we’re cautious about the vast majority of convertible funds available to individual investors. We do, however, like the diversification they provide. We invested in the one that looked solid and are quite pleased.

Of course, I can’t blurt out the name without betraying the trust of our subscribers, so we’re offering a risk-free trial subscription to our retirement-focused newsletter, Miller’s Money Forever. Sign up today and gain immediate access to our favorite convertible bond fund and our entire Bulletproof Portfolio. If it turns out we’re not your flavor, let us know within the first 90 days and we’ll return every penny you paid, not questions asked. Click here to start your trial subscription now.

The article Why There’s Just One Convertible Bond Fund You Should Hold Now was originally published at Millers Money

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Learn to Trust Your Own Financial Judgment

By Dennis Miller

Keep this goal in mind as you read on: solid income and growth with minimal risk and no catastrophic losses. Just tuck it in the back of your head.


Subscriber Brian A. wrote sharing a common concern:

"I subscribe to your newsletter for the purpose of diversifying my portfolio as well as taking more responsibility for my investment future. … I look at the soaring S&P and Dow and wonder if both are appreciating from strong fundamentals, or from the Fed's easy money policy. … I listen to my broker who spouts out information of a resurgence of manufacturing coming back to US soil and (says) equities are the place to be for the near future. The other side spouts banks are insolvent, businesses are closing, (and) if it wasn't for the Fed propping things up we would be in a recession. Some say we are in a recession. I would like to see you devote an article on the subject of the 'don't worry be happy' crowd verses the 'doom and gloom' crowd."

Well, Brian, ask and ye shall receive. My recommendation, as always, is to look at the data, decide for yourself which camp you fall in—if either—and invest accordingly.

Folks who think things are turning around generally point to statistics published by the Congressional Budget Office (CBO). These numbers—the unemployment and inflation rates and the Consumer Price Index in particular—are used by the Federal Reserve to make or change policy. Those decisions affect the economy and the stock market.

If you swallow these numbers, you can point to a trend line going up. You may not think "happy days are here again," but you could make a case that we are headed in the right direction.

In contrast, the "gloom and doom" crowd point to data from statisticians like John Williams at Shadow Government Statistics, who make a good case against the accuracy of official government data. Williams' alternatives to the CPI, official inflation rate, and unemployment rate paint a much different picture.

Unemployment offers an easy example. When a person stops looking for work, the CBO no longer considers him unemployed. I guess that means if everyone just stopped looking, the unemployment problem would be solved.

Many in the gloom-and-doom crowd distrust the government and believe its statistics are produced for the benefit of politicians.

The gap between these two camps is wide. We recently published a special report called Bond Basics, offering safe ways to find yield in the current economy. Shortly after releasing our report, I attended a workshop with one of the top bond experts at a major brokerage firm. As I listened to his excellent presentation, I realized we agreed on many points: interest rates seem to be going up, the value of laddering and diversification, etc. We also agreed that investors (not traders) should buy bonds for one purpose: safe retirement income.

This speaker, however, recommended that baby boomers and retirees buying individual bonds only buy investment grade bonds and ladder them over an eight year period. Each year some would mature, and retirees would then replace them with other eight-year bonds. In a rising rate environment, retirees would eventually catch up he claimed. This expert mentioned inflation only once, remarking that it is "under control" and should remain low.

I went to the company's website and discovered that five year AAA bonds were paying 1.92%, and ten year bonds were paying 3.41%.

Then I went to Shadow Government Statistics. The official inflation rate as indicated by the CPI is hovering around 1.8%. However, using the same method used for calculating the CPI in 1990 (the government has changed the formula many times), the current rate comes to approximately 5.5%.
Now, it only makes sense to invest in long-term, high-quality bonds if you truly believe the government's CPI statistics. If, however, you that suspect inflation isn't quite so under control—even if you don't believe it's 5.5%—why would you invest in an eight-year bond that's virtually certain to lose to inflation?

The same logic applies to unemployment numbers. The official number is around 6.7% and coming down. Alternative calculations show a double digit unemployment rate that is rising. Should you invest heavily in stocks now? It depends again on whom you believe.

How should this affect your approach? If you hold the majority of your nest egg in cash or low-yield investments, you are losing ground to inflation. On the other hand, going all in the market if you are uncertain that the economy is improving could be equally disastrous.

A word of caution: do not let fear of getting it wrong immobilize you! It can be a very costly mistake. Keep learning and researching until you find investments you are comfortable with.

Let's look at the best- and worst-case scenarios with long term bonds. If you follow the advice of a bond salesman, you'll buy long-term corporate bonds. Ten year, AAA rated bonds currently yield around 3.41%. Assuming the bond trader is correct and inflation is not an issue, the best you could earn is 3.41%. Is that enough to get excited about when you factor in taxes and the risk of inflation?

In a recent article, I shared an example of a hypothetical investor who bought a $100,000, five-year, 6% CD on January 1, 1977. If he'd been in the 25% tax bracket, his account balance after interest would have been $124,600 at the end of five years. That's a 25.9% reduction in buying power because of high inflation during that five year period.

In that light, 3.41% does not look quite so appealing. Yes, inflation was particularly high during the Carter era, so apply a bit of common sense to the example. Nevertheless, what has caused inflation in the past? In general terms, governments spending money they don't have and printing money to make up the difference. Argentina is a timely example of this folly.

These concerns are why our research team and I paired up to produce Bond Basics. We think there are better risk and reward opportunities than long-term bonds available in today's market.

Investing in stocks is a different story. We cannot keep up with inflation and provide enough income to supplement retirement needs with bonds alone (unless you have a huge portfolio and are willing to buy higher-risk bonds). That's why our team picks stocks with surgical precision. We run them through our Five Point Balancing Test, recommend strict position limits, diversify across many sectors, and use appropriate stop losses.

Our premium publication is named Miller's Money Forever for good reason. We want to help you grow your nest egg in the safest possible manner under any market conditions. Neither the happy days nor the doomsday crowd can predict the future, so we prepare for all possibilities.

You've likely heard the refrain, "Inflation or deflation? Yes." It's a favorite of our friend John Mauldin. With that, baby boomers and retirees are forced to become kitchen-table economists and to sift through statistics that may or may not be accurate.

I haven't been shy about my opinion: I don't think the economy is improving, so retirees need to risk more than they would like in the market. That's why our Bulletproof Income strategy prepares for all market possibilities as safely as possible.

Whom should you believe? Well, is the person speaking trying to sell you something? Stockbrokers trying to garner your business tend to be optimistic about the economy. If someone is trying to sell gold or foreign currency investments, they are likely to cite a history of rising inflation and explain how their product can protect you. It doesn't mean either is wrong. And yes, the same point applies to the humble authors of investment newsletters.

At Miller's Money we share the reasoning behind every recommendation we make. We want our subscribers to know as much as we do about every pick—pros and cons. If you agree with our reasoning, act on our advice. If not, or if you have additional questions, ask us or sit tight for another pick. Never invest in something you don't understand or are uncomfortable with no matter who recommends it.

The bottom line is you have to read, learn, do your own research, and make your own judgments. Listen to all sides of any argument, and then do what you think is best.

What could be more important to baby boomers and retirees than protecting their money? Take the time necessary to teach yourself. In time you will become more comfortable trusting your own judgment. If you were savvy enough to make money, you are savvy enough to learn how to invest and protect it. Give yourself credit where it's due.


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The article Learn to Trust Your Own Financial Judgment was originally published at Millers Money.

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