The Federal Reserve’s interest rate hiking regime is punishing a variety of fixed income assets, but some bonds have track records of standing tall against rate increases.
That’s the reputation of convertible bonds, indicating that the American Century Quality Convertible Securities ETF (QCON) is among the fixed income exchange traded funds that investors might want to evaluate over the near term.
Supporting the case for QCON are bullish comments on convertibles from Bank of America analysts.
“We reiterate our Favorable View of convertible bond ETFs. Convertible bonds can be thought of as a traditional bond with the option to convert holdings into common stock at the holder’s choice. This structure combines equity beta with meaningful yield,” say the BofA analysts in a recent note.
Among the factors highlighted by the analysts are convertibles’ low durations, high growth yields, and compelling risk-adjusted returns. Obviously, with interest rates rising, the lower durations offered by convertible bonds are attractive to investors. QCON’s duration is just 1.34 years. Plus, QCON can offer some avenue for growth while generating more yield than many growth-heavy equity indexes.
“The convertible bond market is 60% growth stocks with the ETFs in our coverage weighted toward Tech, Healthcare, and Discretionary names. Convertible bond ETFs yield 2.6% on average compared to Nasdaq’s 0.48%,” adds BofA. “Convertible bonds’ hybrid structure offers investors an asymmetric risk profile with smaller drawdowns than equities and more potential upside than longer duration fixed income products.”
Add to that, convertibles beat the domestic aggregate bond market by 2,000% dating back to 1988, according to the bank. QCON held 133 bonds as of the end of last year.
Getting back to duration, QCON is all the more attractive in the current market setting because convertible bonds usually sport lower durations than junk bonds, investment-grade corporates, and U.S. government debt.
“Convertible bonds are also attractive relative to fixed income peers. In addition to attractive yield and equity beta, converts’ equity exposure allow them to be less rate-sensitive than their traditional fixed income counterparts. US converts have an average effective duration of just 1.9, well below that of HY, IG, and government bonds,” adds BofA. “This offers a key benefit to fixed income investors in an environment of rising yields, in our view. We prefer investments with lower interest rate risk (duration) and higher credit risk given resilient fundamentals.”
Additionally, QCON is actively managed, meaning that its managers can fine-tune rate exposure if need be.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.
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