Hey guys how are you doing? I went to FSM fund selector and filtered for ALL fixed income products and sorted by performance over the last 10 years and convertible bonds come on top even better than high yield. Any thoughts if this can be part of the portfolio and the risks involved buying them at this time?
Sooooo this is a fun one! The answer is "because when you're buying convertibles, you're not
really buying fixed-income - they're like bonds with an equity kicker - and also you're basically YOLOing meme stocks".
First, for anyone who doesn't know what a convertible bond is: a convertible bond starts its life like a regular bond, but if the underlying stock rises above a certain level at maturity, the bond gets repaid in stock of the underlying company instead of in cash. That means bondholders participate in gains in the underlying equity; the tradeoff for that sweet deal is that convertibles usually have much lower coupons than straight bonds, and they're usually issued by
really junky companies who can't afford the cashflow drain of the coupons on a regular bond.
(For anyone else with options brain-damage: it's like you're long a call option on the company's stock, and paying for it by lending to the company at a cheap yield.)
These have become very popular lately amongst meme-stock issuers, of all things. The biggest name in ICVT is Microstrategy, which has issued an absolute truckload of convertibles to buy bitcoin. Other names you'll recognize in the top-ten are Coinbase, Uber, SMCI, Gamestop, Rocket Lab... basically every memey stock in the world has started issuing convertibles.
These things go wrong in two ways:
1) If the stock goes
up, they're worse than just owning the stock. For example, you'd rather own Gamestop outright than buy their convertibles and hope they convert.
2) If the stock goes
down, these are generally pretty junky companies, and you're stuck receiving a below-market yield. A lot of convertibles are issued with a zero coupon, or a sub-1-percent coupon, and if you're not getting the equity coupon that's a pretty trash return.
And, three, if the company goes really sideways, they may struggle to repay the converts. (I'm specifically thinking of Strategy here, which, when its NAV premium inevitably disappears in a year or two, is going to have to sell some of its stash of bitcoin to make the payments on these bonds.)
So, don't be led astray by the spicy returns on converts - remember, they're not really fixed income, they're more like an incredibly expensive way to get exposure to meme stocks.
