Convertible funds safe for low-risk takers

MUTUAL FUNDS

February 13, 1994|By WERNER RENBERG | WERNER RENBERG,1994 Werner Renberg

Here's a challenging question for you: What do American Capital Harbor Fund, the Bond Fund for Growth and Pacific Horizon Capital Income Fund have in common?

The answer: They're all convertible securities funds, primarily invested in bonds and preferred stocks that can be converted into shares of the common stock of the companies that issued them.

The funds' names used to indicate what they are: Convertible Securities Fund, Rochester Convertible Fund and Pacific Horizon Convertible Securities Fund, respectively.

But current or past managements decided to change the funds' names, in part to facilitate their marketing; some brokers and other sales people seem to have trouble selling their customers on the concept of convertible securities funds.

Nonetheless, these funds have remained concentrated in convertible securities to achieve their investment objectives of growth and income, and they have been among the category's leaders.

If you have heard about convertible securities funds but have not understood what they were and whether one could be appropriate for a portion of your portfolio, this may be a good time to explore them.

Being linked to common stocks, convertible securities offer the potential for appreciation, even if less than stocks themselves.

But because they provide fixed income -- at rates higher than stocks but lower than nonconvertible issues of comparable quality -- they also should fall less than stocks when the market declines.

With stock prices near record levels, you might wish to consider a convertible securities fund if you are uneasy about the market, yet want to maintain your exposure to equities and be more invested in funds with below-average risk.

Convertible funds -- such as Pacific Horizon's -- may satisfy this desire.

The lower downside risk is not the only reason to consider a well-managed fund. The group's recent average total returns -- 19.8 percent annually for the last three years, 15.8 percent for 1993 -- show that it can beat the performance of both stocks and investment grade bonds.

And while such high absolute performance may not be maintained in the near term because its contributing factors -- substantial drops in interest rates and increases in stock and "junk" bond prices -- could lose their thrust, relative performance should still be respectable.

It's the case made by James H. Behrmann, who has managed American Capital Harbor, the oldest convertible fund, for 10 years.

He projects an average annual return of 11 to 13 percent, based on the 5 to 6 percent average coupon of convertibles that funds own and the expectation that convertibles, whose prices tend to up around 70 percent as much as stocks on the average, could rise 5.5 to 7 percent annually in the next few years if stocks rise only 8 to 10 percent.

Given this scenario, how do you pick a convertible fund?

By screening the leaders for one whose policies you feel comfortable with. They differ in a few ways, such as the emphasis they give income vs. appreciation, premiums over conversion values and other convertibles' data vs. the prospects of underlying common stocks, and "junk" vs. investment grade bonds.

Behrmann, who favors investment grade securities, tries to be diversified among economic sectors in line with their weightings in the S&P 500. For sectors in which no convertibles are available, he invests in common stocks.

Sector bets, however, are just what Bank of America's William S. Hensel credits, in part, for the Pacific Horizon fund's record, which he has managed since its inception before the 1987 crash. In picking convertibles, he works with Jeffrey Malet, portfolio manager of Pacific Horizon Aggressive Growth Fund, a leading stock fund.

Such cross-fertilization is also being used to advantage at MacKay-Shields, where Neil Feinberg manages the MainStay Convertible Fund with Denis Laplaige, who also runs the MainStay Value and High Yield Corporate Bond Funds.

Feinberg analyzes convertible issues to estimate their upside potential and downside risk. If the reward:risk ratio exceeds 3:2, he'll investigate a company's fundamentals and size up its earnings prospects so he can decide if to buy. Unlike other convertible funds that have as much as 20 percent of assets in common stocks and some cash reserves, Michael S. Rosen, portfolio manager of The Bond Fund for Growth since its inception in 1986, tries to keep his fund close to 100 percent in convertibles. Like several others, his fund is heavily invested in "junk" bonds.

Rosen will consider "a wide variety" of companies from large to small, growth and value, and turnarounds. He's "very opportunistic."

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