Convertibles look good this season

Andrew Leckey

August 05, 1992|By Andrew Leckey | Andrew Leckey,Tribune Media Services

The summer of 1992 could be a beautiful time to invest in a convertible. A convertible security, that is.

Convertibles are preferred stock or bonds exchangeable for a specified number of common shares at a set price. They provide investors with solid growth while cushioning them from sudden market drops. They're favorites of cautious folks who want higher income than common stock and greater appreciation than regular bonds.

"With yields an endangered species these days, convertible securities offer significantly higher yield than the underlying common stocks," said Jerry Kuschuk, senior vice president with Prudential Securities.

"Because of their higher yields, convertibles are more price-resistant when the market goes down, though you do lose some upside potential."

Convertible securities are a $75 billion market. This year, $12.7 billion in convertibles have been issued, after last year's record high of $20.4 billion.

Perhaps the strongest selling point is that convertibles aren't subject to the extremes common stocks experience.

The investor receives interest, plus potential capital gain from stock appreciation realized when the bond is converted. While a convertible usually has a provision that gives the issuing firm a chance to call in the convertible at a specified price, it will never sell below its conversion value.

"For investors who are risk-adverse but want yield, the convertible security is a hybrid that offers answers," said Michael Feigeles, first vice president with Merrill Lynch & Co. "The attributes of a convertible the investor must consider are the yield, the premium being paid on the equity side, the quality and rating on the bond side, and the call features and redemption features."

For many investors, the biggest weakness of convertibles may be callability, since you can conceivably lose something you'd really like to own.

"Convertible securities are best for the conservative growth investor and aggressive income investor," said Andrew Offit, manager of the $250 million-asset Fidelity Convertible Securities Fund, up 8.96 percent this year after a 38 percent return last year. "I don't see a lot of bargain prices in convertibles, and, when buying, the investor should also bear in mind that convertibles are typically found in industries that issue them because they need the money."

Big issuers include banks, technology companies, automobile companies, airlines and paper companies.

Some convertibles resemble stocks. Convertibles with conversion premiums under 25 percent may be attractive stock replacements because they combine stock participation with an income advantage over the common stock.

For example, the Ford Motor Co. convertible preferred recommended by Prudential Securities and held by Fidelity Convertible Securities Fund yields 1.8 percent more than the common stock. Yet its price performance should be similar to that of the common stock, given its low 6 percent conversion premium.

Merrill Lynch recommends the convertible preferred of General Motors, which converts to GM "E." In convertible bonds, it suggests Bank of New York and Allegheny Ludlum. Merrill Lynch's LYON (liquid yield option notes) convertible product with zero-coupon features differs from traditional convertibles. Interest is paid only at the date of the LYON's maturity. Two popular LYONs are Eastman Kodak and Automatic Data Processing.

Largest holdings of Fidelity Convertible Securities Fund include convertible preferred of CBS Inc. and Citicorp. Convertible preferred favorites of Prudential are Banc One, ConAgra Inc. and Delta Air Lines.

"Sometimes it's frustrating because, if I find a company I really like, I know you won't get the performance out of a convertible you would from a regular stock," Mr. Offit said. "If a stock goes up 20 percent, a convertible will go up just 10 percent, but, of course, the convertible limits the downside as well."

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