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"What are some alteratives to stocks?" Round 3: Convertible Bonds

All This week, we’re looking alternative investments to stocks to help diversify your investment portfolio, and hopefully will help reduce your drawdowns in times when the market behaves like it has these last couple of weeks.

As a reminder, you can go to www.hyllandcapital.com/ask to find previous recordings. This week so far we have touched on REITs, or real estate investment trusts and preferred shares.

Today we are moving on to looking at convertible bonds.

Transcript - Investing in Convertible Bonds

Convertible bonds are securities that pay a regular interest payment, just like any other bond, but also have the option to be converted into a certain number of share of common stock of the issuing company.

For example, Tesla had convertible bonds outstanding that you purchased for $1,000 and they paid 2.37% interest. But, at any time you could convert that bond into 3 shares of tesla common stock.

These types of issues have historically outperformed bonds since a large portion of their value is actually tied to the value of the company’s stock.

For that reason, these types of securities tend to not add a lot of diversification to your portfolio, but really just more stock exposure with a slightly higher yield. In fact, they have a 0.9 correlation to the stock market.

Over the last decade, convertible bonds have achieved returns of 11.1 percent per year. That is lower than stocks, which have achieved 12.7%, but convertible bonds have had slightly less volatility.

But again, most of their return is actually due to the rising stock market. In general these provide very little diversification to stocks.

In the end, we don’t use these for our clients at Hylland Capital because their returns can easily be replicated with a mix of stock and bond funds for a lower cost and lower volatility. However, that doesn’t mean they are wrong for everyone.

Matt Hylland