Mutual funds holding convertible bonds and convertible preferred stocks lost more than 33 percent last year, on average, the worst performance in many years. Besides the general turmoil in financial markets, convertibles were sold heavily by distressed hedge funds, putting downward pressure on prices. Now convertibles funds may be good buys, offering high yields plus upside potential.
The bonds and preferred stocks held by these funds pay substantial yields so convertibles funds may now pay appealing dividends. Moreover, the bonds and preferred stocks can be converted into the issuer’s common stock so investors may gain ground if the stock market recovers.
Morningstar’s pick in this category is Vanguard Convertible Securities, which currently yields over 4 percent. Its 10-year total return of 4.6 percent a year is among the best for convertibles funds. A much higher yield (over 8 percent) is offered by Franklin Convertible Securities, which has posted a slightly lower long-term return than the Vanguard fund.