Please share your view of convertible bonds as an asset class for folks entering retirement.
Convertible bonds are a unique asset class in that they have features of both stocks and bonds. They are often referred to as “hybrid” securities. This, along with their typically sub-par credit rating, is why they do not fit into our bond portfolio.
We prefer to keep the stock and bond components of our portfolios separate. Our bond portfolio is designed to buoy the allocation in times of stock market stress. The potential for convertible bonds to act like stocks does not jive with this logic. If convertibles – due to their hybrid nature – were showing stock-like tendencies when stocks were declining, your portfolio would have much less downside protection. As we have seen in the recent past, it is extremely important that investors maintain some level of protection in their portfolio. We do not believe convertible bonds are the solution.
Also worth your consideration is the credit quality of convertible bonds. Our MarketWise tax-deferred bond allocation uses exclusively US government and treasury debt (we also use municipal bonds in our MarketWise tax-managed bond allocation). This supports your portfolio when the stock markets fall. How it works is pretty straightforward. During a recession or market correction, there is typically a flight to quality. One of the most sought after destinations for this flight is US government and treasury debt. If people are flooding into these securities, guess what happens to their price? That’s right, it goes up. When stocks are falling this is exactly what your portfolio needs. Convertible bonds do not offer this same level of protection. In fact, they are typically offered by companies with poor credit ratings. This translates to increased risk for your portfolio. At the end of the day, we don’t think convertible bonds are a substitute for high quality bonds.
We look to our bond portfolio for security and capital preservation. In this context, convertible bonds are simply not a good fit.