African mining companies. A couple of hybrid funds are 50 percent invested in gold and 50 percent in government bonds. For the extremely skittish investor who worries about both the coming Depression and the coming Hyperinflation, this is an appealing mix.
CONVERTIBLE FUNDS
This is an underrated way to enjoy the best of two worlds: the high performance of secondary and small-cap stocks and the stability of bonds. Generally, it is the smaller companies that issue convertible bonds, which pay a lower rate of interest than regular bonds. Investors are willing to accept this lower rate of interest in return for the conversion feature, which allows them to exchange their convertible bonds for common stock at some specific conversion price.
Customarily, the conversion price is 20â25 percent higher than the current price of the common stock. When the price of the common stock reaches this higher level and beyond, the conversion feature becomes valuable. While waiting for this to happen, the bondholder is collecting interest on the bond. And whereas the price of a common stock can fall very far very fast, the price of a convertible bond is less volatile. The yield holds it up. In 1990, for instance, the common stocks connected to the various convertible bonds were down 27.3 percent, while the convertible bonds themselves lost only 13 percent of their value.
Still, there are certain pitfalls to investing in convertible bonds. This is one field thatâs best left to the experts. The amateur investor can do well in one of the numerous convertible funds, which deserve more recognition than they get. Today, a good convertible fund yields 7 percent, which is far better than the 3 percent dividend that you get from the average stock. The Putnam Convertible Income Growth Trust, to name one such fund, has a 20-year total return of 884.8 percent, which beats the S&P 500. Few managed funds can make such a claim, as weâve already seen.
At the nameless New England charity, we invested in no fewer than three convertible funds, because at the time convertibles seemed undervalued. How could we tell? Normally, a regular corporate bond yields 1½ to 2 percent more than a convertible bond. When this spread widens, it means convertibles are becoming overpriced, and when it narrows, the reverse is true. In 1987, just before the Great Correction, regular corporate bonds yielded 4 percent more than convertibles, which meant that the convertibles were extremely overpriced. But during the Saddam Sell-off in October 1990, convertible bonds were actually yielding 1 percent more than regular bonds issued by the same companies. This was a rare opportunity to pick up convertibles at a favorable rate.
Hereâs a good strategy for convertible investing: buy into convertible funds when the spread between convertible and corporate bonds is narrow (say, 2 percent or less), and cut back when that spread widens.
CLOSED-END FUNDS
Closed-end funds trade as stocks on all the major exchanges. There are 318 of these at current count. They come in all sizes and varieties:closed-end bond funds, municipal bond funds, general equity funds, growth funds, value funds, etc.
The main difference between a closed-end fund and an open-ended fund such as Magellan is that a closed-end fund is static. The number of shares stays the same. A shareholder in a closed-end fund exits the fund by selling his or her shares to somebody else, the same as if he or she were selling a stock. An open-ended fund is dynamic. When an investor buys in, new shares are created. When the investor sells out, his or her shares are retired, or âredeemed,â and the fund shrinks by that amount.
Both closed-end funds and open-ended funds are basically managed the same way, except that the manager of a closed-end fund has some extra job security. Since the fund cannot shrink in size due to a mass exodus of customers, the only way he or she can fail is to generate losses in the
CONVERTIBLE FUNDS
This is an underrated way to enjoy the best of two worlds: the high performance of secondary and small-cap stocks and the stability of bonds. Generally, it is the smaller companies that issue convertible bonds, which pay a lower rate of interest than regular bonds. Investors are willing to accept this lower rate of interest in return for the conversion feature, which allows them to exchange their convertible bonds for common stock at some specific conversion price.
Customarily, the conversion price is 20â25 percent higher than the current price of the common stock. When the price of the common stock reaches this higher level and beyond, the conversion feature becomes valuable. While waiting for this to happen, the bondholder is collecting interest on the bond. And whereas the price of a common stock can fall very far very fast, the price of a convertible bond is less volatile. The yield holds it up. In 1990, for instance, the common stocks connected to the various convertible bonds were down 27.3 percent, while the convertible bonds themselves lost only 13 percent of their value.
Still, there are certain pitfalls to investing in convertible bonds. This is one field thatâs best left to the experts. The amateur investor can do well in one of the numerous convertible funds, which deserve more recognition than they get. Today, a good convertible fund yields 7 percent, which is far better than the 3 percent dividend that you get from the average stock. The Putnam Convertible Income Growth Trust, to name one such fund, has a 20-year total return of 884.8 percent, which beats the S&P 500. Few managed funds can make such a claim, as weâve already seen.
At the nameless New England charity, we invested in no fewer than three convertible funds, because at the time convertibles seemed undervalued. How could we tell? Normally, a regular corporate bond yields 1½ to 2 percent more than a convertible bond. When this spread widens, it means convertibles are becoming overpriced, and when it narrows, the reverse is true. In 1987, just before the Great Correction, regular corporate bonds yielded 4 percent more than convertibles, which meant that the convertibles were extremely overpriced. But during the Saddam Sell-off in October 1990, convertible bonds were actually yielding 1 percent more than regular bonds issued by the same companies. This was a rare opportunity to pick up convertibles at a favorable rate.
Hereâs a good strategy for convertible investing: buy into convertible funds when the spread between convertible and corporate bonds is narrow (say, 2 percent or less), and cut back when that spread widens.
CLOSED-END FUNDS
Closed-end funds trade as stocks on all the major exchanges. There are 318 of these at current count. They come in all sizes and varieties:closed-end bond funds, municipal bond funds, general equity funds, growth funds, value funds, etc.
The main difference between a closed-end fund and an open-ended fund such as Magellan is that a closed-end fund is static. The number of shares stays the same. A shareholder in a closed-end fund exits the fund by selling his or her shares to somebody else, the same as if he or she were selling a stock. An open-ended fund is dynamic. When an investor buys in, new shares are created. When the investor sells out, his or her shares are retired, or âredeemed,â and the fund shrinks by that amount.
Both closed-end funds and open-ended funds are basically managed the same way, except that the manager of a closed-end fund has some extra job security. Since the fund cannot shrink in size due to a mass exodus of customers, the only way he or she can fail is to generate losses in the
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