Convertible bonds trounced the rebounding stock market in 2009, with the Merrill Lynch All Convertibles All Qualities Index returning 49.1% to the S&P 500's 26.5%. Investors noticed, and assets flowed into convertible bond mutual funds. Calamos Convertible (CCVIX), one of the oldest and best in the field, saw assets more than quadruple, to more than $3 billion.
Is there any upside left for those who missed out? In an interview with reporter Laura Lallos, fund manager John Calamos Sr., 69, argues that convertibles remain attractive. The bonds pay interest but also can be exchanged for shares of stock. If the stock goes up, so does the price of the bond; if the stock goes down, the coupon provides a cushion. An example: While Intel's (INTC) stock fell 36% during the last four months of 2008, its 1.5% convertible bond maturing in 2011 lost 12%. The Calamos Convertible Fund, which held the bond, lost 21.6% for the period, vs. the S&P 500's 29% fall.
With an annualized 4.5% return over the past 10 years through Feb. 23, Calamos Convertible has outperformed the S&P 500, which lost 0.4%, and the Merrill Lynch index, which gained 1.9%. Since John Calamos is concerned about the U.S. economic outlook, Calamos Global Growth & Income may be even more desirable—with half of its portfolio in convertibles, it has one of the strongest 10-year risk-adjusted records among world stock funds.
What is the case for convertibles?
Convertibles are still undervalued. They went down more than they should have in 2008 [as hedge funds liquidated], so the rebound was partly closing that valuation gap. New issuance in 2009 also created plenty of opportunities.
So much money has gone into the bond market, yet inflation may be right around the corner. I started in this business in the 1970s, when inflation cratered the bond market and the equity markets went sideways for more than a decade. Convertibles ended up being the best-performing asset class.
The highest-yield bonds did best last year. Were you tempted to dip down in quality?
Such a strategy would have worked out very well last year, but downside safety is important to us, so we avoid the most speculative issues.
How should investors allocate convertibles within their portfolio?
We position them as a defensive equity strategy. We aim to achieve 75% of the upside of equities with 25% of the downside. If you like dividend-paying stocks, you're going to love convertibles. On average, you will get twice the income, maybe more, and still have upside potential if stocks keep going up. And you have relatively moderate interest-rate risk.
Are foreign convertibles more attractive than domestic now?
After what has happened over the past couple of years, we recommend investors think more globally than ever before. The last time we found ourselves facing inflation and economic and political uncertainty, in the 1970s and the early '80s, there was no place else to go because it was difficult to invest outside the U.S. Not that we are negative about the U.S. per se, but there are good opportunities overseas. Of course, there is sovereign risk; consider Greece. But if one government is wrongheaded, the financial markets will punish it and the flows will go elsewhere.
Does Calamos Convertible have foreign exposure?
It will have some foreign exposure, but it is U.S.-centric. Calamos Global Growth & Income (CVLOX) invests in stocks and convertibles around the world. It has 37% in Europe, 34% in the U.S., 7% in Canada, 9% in emerging Asia, plus stakes in other emerging markets. I think the global convertible market will give us more opportunities.