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Established investors are becoming more aware of the importance of supplementing their income with equity-oriented investments to help outpace the effects of inflation. Convertible securities (convertibles) offer the potential advantages of debt and equity securities, combining attractive yields of traditional fixed-income securities with the capital-appreciation potential of common stocks.
Opportunity for equity participation
Generally, convertible securities may be exchanged at any time for a fixed number of shares of their underlying common stock. This option provides the potential for significant growth.
Many convertibles tend to outperform common stocks in a falling market, because their higher yields cushion the effects of a market decline. In a rising equity market, convertibles provide an opportunity for capital growth, although they tend to appreciate less than common stocks. In a stable equity market, convertible securities' higher yields and conversion feature provide attractive total returns.
Greater control of investment
Most convertibles can be exchanged for shares of common stock, but there is no obligation to do so. During periods of economic uncertainty or market unrest, investors can hold on to their convertible option.
Relative safety/credit quality
Convertible securities rank senior to an issuer's common stock and thus tend to entail relatively less principal risk.
Convertibles generate fixed-rate returns that are typically higher than the underlying common stock. Dividends or interest is usually paid quarterly for convertible preferred stocks, and semiannually for convertible bonds. Interest "accretes" semiannually and is paid out only at maturity or on the "put" date(s) specified when they are issued.
The convertible securities market offers a selection of attractively structured vehicles.
Each is designed to meet different investor needs. Convertibles may be selected on the basis of industry type, credit rating, yield, premium, call protection, capitalization, investment style and maturity.
Convertibles are subject to price fluctuations. If sold prior to maturity, their value may be more or less than their original cost. Most convertibles are listed on either the New York Stock Exchange or the American Stock Exchange. The majority of transactions, however, occur in the over-the-counter market.
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