Over the long term, convertibles have proven to be a useful portfolio diversifier. They typically capture much of the equity market upside while providing downside protection and low correlation to other fixed-income asset classes. Over full market cycles, they also typically deliver an equity-like return, a higher Sharpe ratio and a lower standard deviation compared to common stock.
The addition of convertible securities provides the potential to improve most portfolios' efficient frontiers by offering highly compelling risk-adjusted returns.
While convertibles have historically provided very strong risk/return characteristics for investors, the convertible market has undergone a significant positive structural transformation during the past decade, which provides an even more compelling risk-return profile for the future. Shorter maturities have improved downside protection, longer call protection has helped to increase equity market participation, and the ownership shift to more stable long-only investors from levered hedge funds have all contributed to make the asset class even more attractive.
Since 1973, the broad convertible market has closely tracked the performance of the S&P 500 with lower risk by providing downside protection and the ability to allow investors to sleep calmly at night. Whether markets continue to rise or start to sell off, convertibles represent the capital markets' ounce of prevention in anticipation of more challenging markets, and its pound of cure during periods of high turbulence and distress.
Tracy Maitland is president and chief investment officer, and Robert Farmer and Hart Woodson are managing directors, portfolio management, with Advent Capital Management LLC, New York. This content represents the views of the authors. It was submitted and edited under P&I guidelines, but is not a product of P&I's editorial team.