Convertible market looking better than high-yield, say top closed-end convertible fund managers

By Kenneth Lim

Boston, May 3 - The Advent Claymore Convertible Securities and Income fund gave the best returns among closed-end convertible funds during the first quarter of 2006, says Thomas J. Herzfeld Advisors Inc. in its latest Investors's Guide to Closed-End Funds.

And managers of the top two convertible funds in terms of net asset value say the convertible bond market is beginning to look more interesting after languishing in the shadow of high-yield securities in the past few years.

In its latest report, Herzfeld ranked the Advent fund as giving the best returns on net asset value out of 11 closed-end convertible funds, with a gain of 5.4% in the first quarter of 2006. The Ellsworth Fund was second with a 5.27% net asset value return while the Gabelli Convertible and Income Securities fund came in third at 5.16%. The average net asset value return from the closed-end convertible funds was 4.44%, better than the 1.66% returns from bond funds but less than the 6.4% from equity funds.

The Advent fund also topped its asset class in terms of price, gaining 14.21% in the first quarter. The next two spots were taken by the Nicholas-Applegate Convertible and Income Fund II, at 12.43%, and the Nicholas-Applegate Convertible and Income Fund, which returned 9.90% based on price.

Funds diversify but managers like converts

"The convertible group has undergone has undergone much change over the past year, with most funds expanding their investment latitude; few focus their investments solely in convertibles any more," the report said.

But the portfolio managers at Ellsworth and Advent said convertible securities are starting to make a comeback, and neither expects to reduce their convertible exposure any time soon.

"A portion of our funds is in high-yield bonds, and you can infer that one way we've achieved good performance is by cutting back the investment in high-yield...as high-yield yields have gotten lower and credit spreads have tightened," said Advent Capital Management research director Barry Nelson, who also manages the Advent Claymore convertible fund.

Nelson, who noted that "the returns on high-yield are not what they were three years ago," said the economy is now going through a "Goldilocks 2" phase of "strong economic growth with low inflation."

"American companies have marshaled their cash flow, they haven't been excessive with capital spending, they have not behaved in a euphoric way so that cashflow and balance sheets are in good shape, inflation is low," Nelson explained.

Equity markets also tend to lag the corporate bond markets, and the corporate bond market "has not begun to tank," Nelson said.

Nelson sees 'good returns'

"Stocks will continue to do better. Convertibles obviously embody the upside potential of the stock, so from convertibles we continue to have the potential for good returns," Nelson said. "It's a dead end with high-yield. The yields are too low, the spreads are too tight."

Thomas Dinsmore of Davis-Dinsmore Management Co., who is the chairman and chief executive of the Ellsworth Fund, also said he does not plan to reduce his exposure to convertibles even though the fund recently removed any mention of convertibles from its name with change of name from the Ellsworth Convertible Growth and Income Fund.

"We frankly don't intend to reduce our exposure to converts," Dinsmore said, adding later: "Would it surprise me if over the next few years we average over 90% in terms of our exposure to convertibles? No."

Dinsmore said the decision to remove the word "convertible" from the fund's name was a reaction to regulations that require funds to invest at least 80% of their assets in the asset class mentioned in its name. Ellsworth only needs to invest 65% of its assets in convertible securities, and Dinsmore said he did not want to be "constricted" if convertibles start losing their attraction again like in 2003.

"What we saw in 2003 in particular was the high-yield bond market was so much more attractive compared to the convertible market...Let's face it, the Calamoses of the world did extremely well by buying high-yield securities during that period," Dinsmore said.

But the convertible bond market has been looking better, he said.

"I'm not going to say that this is a run, don't walk, buy 'em now kind of market," he said. "It certainly is a very rational market. Most of the new deals that we've seen coming out have been priced properly... I think that the convertible market right now is appropriate."

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