Of course, we’d argue that convertible securities are appropriate for strategic portfolio allocations, as a means of seeking lower volatility equity exposure over full and multiple market cycles.

But as interest rates rise, it’s that time in the cycle when many advisors are turning to convertibles for shorter-term tactical overweights. Convertible bonds, which combine characteristics of stocks and traditional fixed-income securities, have historically outperformed fixed income during periods of rising interest rates (see the analysis in our Readying Your Clients’ Portfolios for Rising Interest Rates post).

If you’re evaluating convertible funds now, make sure you recognize the difference between what an actively managed fund does versus a passive.

The Complexities of a Single Security and the Market as a Whole

In our view, those who seek to buy “the market” via a passive fund defeat the purpose of investing in convertibles securities. Here’s why:

  • Convertibles combine characteristics of stocks and traditional fixed income securities, providing unique opportunities for managing risk and enhancing returns.
  • The characteristics of a single convertible may change over time. Convertible securities have varying degrees of equity and fixed income sensitivity, and these characteristics may change for a given convertible over time.
  • At various times, the convertible market as a whole—and thereby the passive fund tracking it—may look a lot like the equity market and other times a lot like the bond market.