Can you stay in today's turbulent markets and still sleep at night? Convertible bonds offer one option. Convertibles can be exchanged for stock at any time during the life of the bond. They often provide as much as two-thirds of the gains you'd get from the underlying equity--at half the risk. Says James Peattie, manager of international convertible research at Merrill Lynch in London: "They tend to be a safe haven in a falling market."
Here's how it works. British cable and telecom company Telewest Communications has issued a convertible equivalent to $1,600 with a 5.25% annual coupon. Each bond can be exchanged for 307.7 shares of Telewest stock over its eight-year life. If an investor hasn't swapped the bond for shares at maturity, the $1,600 face value is repaid.
PROTECTION. Issued in February, 1999, the Telewest bond is now selling at $2,100, with a conversion premium of 11.37% over the current stock price. Although the underlying stock has climbed 50%, the bond has risen 31%. So, while investors missed some of the equity return, they also missed out on potential losses. Since the market peaked on Mar. 10, the stock has dropped 22%, while the bond has declined 18%. A Mar. 6 issue by Colt Telecom gave investors similar protection.
When they're first issued, convertibles are often valued between equities and bonds. But rising stock prices can push the convertible's price up so high that the bond behaves like the share. With the appreciation in the stock market in the last few years, many European convertibles fall into this category. If stock prices tank, however, convertibles begin to behave like straight bonds as they approach maturity.
RETAIL BASE. The convertible market in Europe is now worth about $115 billion, and the telecom, media, and technology sectors account for about a third of it. That's likely to grow as the New Economy expands and companies in these sectors seek more capital. Once the preserve of institutions and wealthy individuals, convertibles are also expected to develop a broader investor base. A recent issue by Germany's Mannesmann targeted 10% for retail investors.
You want to get in now? Grant Mackie, head of international convertible research at Lehman Brothers in London, picks a France Telecom issue that's exchangeable--meaning it converts into stock in a different company, in this case Panafon Hellenic Telecom, a Greek mobile-phone company. It has a 4.125% coupon and is priced at $1,022--107% of face value. Mackie also likes ASML Lithography Holding, a Dutch high-tech electronics company. It's currently priced at 116.75%, which means $11,675--a bit beyond some investors.
There are things to watch for. Pay attention to the credit rating. Also check whether the issuer is allowed to call the bond--in which case you have to redeem it. Convertibles also can have different twists. Two bond offerings from Netherlands-based Versatel Telecom International, for instance, redeem above their issue prices.
One of the best ways to get into convertibles is through funds. Listings can be found on Micropal's Web page (www.micropal.com). The French have an array of convertible bond funds. Watch for those with SICAV (Societe d'Investissement a Capital Variable) accreditation, such as CIC's Converticic Fund and Cardif Convertibles Europe. Another option is GAM's Special Bond Funds, which come in sterling, Swiss franc, and dollar denominations.
You sacrifice some upside potential when you invest in convertibles. But, with the hair-raising volatility of tech stocks these days, that can be a price worth paying.