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Why Convertible Bonds Make Sense Now

by Gary D. Halbert
December 6, 2011


1.   A Little-Known Asset Class

2.   Why Convertible Bonds?

3.   The Wellesley Advantage

4.   Hear it Straight From the Advisor

5.   Convertibles Are “On Sale”


I think everyone reading this knows we are in one of the most treacherous and volatile stock market environments in history.  If asked to describe market conditions over the last year or two, most investors would say, "absolutely crazy!"  Virtually everyone is looking for some other place to invest that has less potential risk than buying stocks or equity mutual funds. At Halbert Wealth Management, we have just such an opportunity with Wellesley Investment Advisors, which invests in convertible bonds.

Yet what is most frustrating to me is the fact that most investors don't know much about convertible bonds, much less understand how they can deliver outsized returns with lower risks, if selected properly.  Because of this lack of knowledge, most investors don't give them a serious look, even now when convertibles offer such a great opportunity relative to traditional stock and bond investments.

I happen to believe that most sophisticated investors should have an allocation to convertible bonds in their portfolios, and I also believe that Wellesley Investment Advisors is the place to be.  With a 16-year track record and average annual returns of almost 10% (net of all fees and expenses), I believe most investors reading this should take a serious look at Wellesley right away.  (Past performance is not necessarily indicative of future results.)

Another good reason to check out Wellesley right now is that these bonds are “on sale” according to Greg and Michael Miller, Wellesley’s portfolio managers.  What does this mean for a convertible bond offering?  Read on and you’ll find out why now may be an excellent time to consider this little-known asset class for your portfolio.

And there is one more thing you should know before we jump into today’s discussion. As long-time readers know, I have my own money invested with EVERY money manager we recommend. What you don’t know is that I have the largest allocation of my own money invested with Wellesley. I really believe in this strategy, and this is why I urge you to take a serious look at Wellesley now.

Why Convertible Bonds?

Historically, equities have provided a higher average annualized return than bonds, but along with this higher average historical return has been an increased level of risk. However, this “risk premium” doesn’t always manifest itself, as many investors painfully discovered during the two bear markets we’ve had since 2000. 

That experience made it clear that to access the potential gains of the stock market, you may also subject yourself to the possible risk of losing a substantial part of your nest egg. Because of the high volatility inherent in the equity markets, Wellesley sought a way to participate in the market’s upside, but also have a measure of downside protection along the way. They found just such a vehicle in the form of convertible bonds.  

A convertible bond is simply a corporate bond that can be exchanged for a specific number of the issuing company's shares of common stock.  The conversion feature is typically included as an incentive for the holder to accept a rate of interest lower than prevailing rates.  Buyers of these types of bonds hope that an increase in the value of the underlying stock will raise the value of the convertible bond.

Thus, the conversion privilege allows bondholders to participate in the upside potential of the underlying stock, yet have some underlying principal protection at the bond’s maturity or at certain “put” option dates prior to maturity.  Of course, any principal protection ultimately relies on the issuer’s financial ability to retire the debt, which is why Wellesley’s fundamental analysis of each convertible bond issue is such an important factor in their success.

Convertible bonds are typically sold at a conversion price representing a premium over the current stock price, meaning that the stock must appreciate in order for the bond to become more valuable.  While there is a yield(interest rate)component to most convertible bonds, Wellesley manages its bond portfolio primarily for capital gains, with any interest earnings being icing on the cake.

Perhaps the most valuable feature of convertible bonds is the “put” option available in many of these offerings. This option allows the bondholder to redeem it for cash or stock at pre-determined prices at various points in time. Thus, while the price of a convertible bond will likely fluctuate over the life of the bond, the availability of the “put” option can help to stabilize the bond price, assuming the financial condition of the issuer remains stable.

The Wellesley Advantage

The way Wellesley limits investment risk is by managing for “absolute returns,” which is a strategy with the goal of producing positive returns in both up and down markets.  Based on Greg Miller’s extensive research and experience, he feels one way investment risk can best be managed is by investing in a diversified portfolio of individual convertible bonds.

As I noted above, convertible bonds can be converted into common shares of the issuing company, which makes them a hybrid investment of sorts.  However, the “put” option is the feature that offers a great deal of additional investment flexibility, to the investor’s advantage. 

The put option is, in essence, an interim maturity date upon which the bond can be liquidated at a known price.  Thus, while the price of a convertible bond may fluctuate based on market conditions, the availability of the put option can help to stabilize the value of the bond.

Wellesley’s investment strategy is a four-step process that employs fundamental analysis as a means to evaluate convertible bond issues.  First, Wellesley screens the convertible bond universe to find issues that meet their strict standards.  They typically look for convertible bond issues that are “investment grade,” that have attractive “put” and “call” provisions and an appropriate equity premium.

Next, Greg and his team put their financial analysis skills to work in researching the companies issuing the bonds. Greg primarily seeks companies with growing profits and at least 10 years of positive growth. He also seeks 10 years of continued strengthening of the corporate balance sheets and strong management performance. The stock of the company should also be at a satisfactory “valuation multiple” in relation to its peers and the market as a whole.

It is also important to note that Greg and his team do not rely on the major credit rating agencies when doing their financial analysis on prospective issuers.  Greg did not trust these agencies even before the credit crisis revealed how unreliable their ratings can be.

Third, economic factors are then considered that might affect the bond issue being reviewed. Greg and his research team consider the overall economic outlook, interest rate projections, prospects for the sector and industry, and reach a preliminary investment decision. Wellesley’s goal is to select convertible bonds with the potential to produce an average absolute return of 10% or more annually over 5 to10 year periods without annual losses.

The final step of the process is to determine whether to buy a particular issue or pass it by. Additional screens and requirements are considered, with the overall goal of not losing money. This same analysis is also performed regularly on the existing bonds held in client accounts.

Wellesley constantly monitors each position in relation to the strength of the issuer, conversion value of the bond and any upcoming “put” and “call” dates. Wellesley calls this ongoing review their “buy, hold, sell, put or convert decision.”  While you may find conventional brokers who will sell you a convertible bond, few are likely to understand the importance of the put options and how to execute them to your advantage, much less provide this level of hands-on active involvement and rigorous due-diligence.

The importance of effective fundamental analysis cannot be overemphasized.  Convertible bonds have all of the normal characteristics of most other bonds (maturity date, interest rate risk, default risk, etc.), so it is important to determine the financial health of the company issuing the bond.  However, a major factor in the potential growth of a bond’s value is based on the underlying stock.  Thus, Wellesley’s analysis goes far beyond the company’s ability to retire the debt and seriously considers its long-term prospects in relation to its stock price.

Wellesley’s Performance Record

Anyone who says that a convertible bond program can’t produce a reasonable return with limited risk obviously hasn’t seen Wellesley’s actual track record.  While much has been written about the stock market’s “lost decade,” Wellesley’s performance seems to defy gravity.  From its inception in January of 1995, Wellesley’s Limited Risk Investing program has produced an annualized return of almost 10% through October 2011, compared to the unmanaged S&P 500 Index that returned just over 8% over the same time period.

Most important, the Wellesley convertible bond strategy produced these returns with an eye on limiting risks, something that index mutual funds simply can’t do.  For example, Wellesley’s worst peak-to-valley drawdown since its inception is -18.2%.  Compare that to the S&P 500 Index’s worst drawdown of -50.9% over the same period of time and you can see the value of risk management.  The charts and tables below tell a more complete story of Wellesley’s actual performance over the years – and remember that this performance is net of management fees and transaction costs.  Past performance, however, is not necessarily indicative of future performance.

Wellesley Performance

Because Wellesley purchases individual bonds on behalf of account holders, the minimum investment for their convertible bond program is somewhat higher than for the mutual fund-based strategies that we recommend.  A higher level of investment is needed to provide sufficient diversification among various convertible bond issues as well as to tailor the account to meet the specific needs of the individual investor. 

Since investors are placed into convertible issues available at the time of their investment, few investors will have exactly the same bonds in their portfolios.  Call one of our Investment Consultants at 800-348-3601 to learn more about Wellesley’s minimum investment requirement.

Hear it Straight from Greg Miller

Back in October, we sponsored a live webinar event featuring Wellesley’s Limited Risk Investing opportunity.  Wellesley’s founder and CEO, Greg Miller, CPA, walked participants through his background as a money manager and the methodology he uses to select individual convertible bonds for his clients.

You can benefit from Greg’s discussion of the Wellesley strategy through a recorded version of the webinar now available by clicking on the link below.  In this presentation, you will not only learn how Greg manages money, but also how his entry into the money management business was influenced by the experiences of his father and grandfather (this is an amazing story!).

You’ll also learn how a change made in convertible bond offerings in 1995 (i.e. – the “put” options) has made them a natural choice for investors seeking absolute returns, especially during uncertain markets.  You’ll discover how Wellesley uses this historical stability to attempt to reduce risk on behalf of their clients and, best of all, why the threat of rising interest rates could actually be good news for investors holding professionally selected convertible bonds.

Greg said that by the time the webinar was over, our listeners would know more about convertible bonds than over 90% of investors.  Thus, you owe it to yourself to listen in on this very informative look at an asset class that is not well known, but could be the key to reaching your financial goals.  Just click on the link below to play or download the recorded Wellesley webinar today:

Wellesley Webinar Recording Link

Convertible Bonds are “On Sale”

We recently received an article from Wellesley Investment Advisors penned by Michael Miller, Co-Chief Investment Officer and son of Wellesley’s founder, Greg Miller, CPA.  The subject of Michael’s article caught my eye in that it mentioned that convertible bonds are now “on sale,” and that there are opportunities for yield that we haven’t seen since the dark days of 2008.  

Obviously, securities like stocks and bonds are not commodities that can be sold at a discount in your local grocery store.  However, they are priced assets and, as such, can be subject to periods of time when the price and yield relationships are more attractive than at others.  Here’s what Michael said about the market environment we’re in right now:

“The news from corporate America continues to be relatively positive, with many companies releasing strong quarterly numbers and positive earnings forecasts. Nevertheless, market volatility has continued to spread across almost all asset classes including the fixed income markets. In the wake of the broad sell-off in August and September, many convertible issues now offer very compelling risk/reward characteristics. Some convertible bond yields are at their highest levels since 2008. In many cases investors can find convertible yields equivalent to or better than straight bonds, but issued by stronger companies, and with shorter maturities. Today’s convertible market appears to be “on sale”, as many high quality bonds trade below par with attractive yields to worst.”

For anyone who may not be familiar with bonds, the “yield-to-worst” statistic is simply the lowest potential yield on a bond without the issuer actually defaulting.  In other words, it’s a worst-case yield scenario that factors in both put and call options on the bond in addition to its coupon and maturity.  Thus, it stands to reason that the more convertible bond prices are depressed, the better the yield-to-worst becomes.  Michael goes on to say:

“Volatile market conditions produced by global economic uncertainty have produced price dislocation across multiple asset classes. While many can make an argument that equities and other securities are also available at cheap prices, investors are generally not willing to risk further decline. In volatile times, there is no substitute for the promised return of principal offered by corporate bonds. However, the present low interest rate environment makes Treasuries and many corporate bonds a poor alternative: modest rates, longer terms, and no upside participation.

Markets are always difficult to predict. However, global economic events seem unlikely to resolve quickly, and will most likely continue to cast a deep shadow on markets into 2012. Unlike corporate and municipals, the equity sensitivity of convertibles allows them to leverage bullish market movements, when they do occur. If markets remain negative or retreat even further, the uncommonly strong yields on convertible bonds can add considerable positive momentum to any investment portfolio…”

An obvious question at this point in time is whether the stock market rally we had last week affected the number of convertible bond issues now “on sale.”  Anticipating that question, I called Wellesley and asked that question.  Their response was that the recent market rally has reduced yields on convertible bonds somewhat, but not to where they were before the market troubles.  Recall that this rally was preceded by a major downward move, so the bounce is just getting back to a previous level of elevated yield, but not down to where it was earlier in the year. 

In other words, convertible bonds are still “on sale!”


Wellesley’s Limited Risk Investing program is one of the most interesting and unique investment strategies I have ever seen.  As I noted earlier, I have my largest single allocation in my personal portfolio with Wellesley. 

Convertible bonds, especially those that include “put” options, offer entry and exit strategies – and opportunities to limit risk – that most investors would never know about.  This investment niche is largely the domain of very sophisticated institutional investors, hedge funds and the like.

Yet Wellesley’s founder, Greg Miller, has spent years refining his skills in this complicated convertible bond arena, not only to be able to manage his own wealth successfully, but also to make his strategy available to individual investors such as our clients.  Greg is a real class-act, in my opinion, which is a big reason why I have so much of my own money invested with Wellesley.

I feel that the Wellesley Limited Risk Investing program could be an excellent choice in any market, but especially in the current uncertain market environment and in light of Wellesley’s opinion that they are “on sale.”  I think you owe it to yourself to at least check out this program to see if it can complement your other allocations.

My recommendation to you today is that you take a serious look at Wellesley right away so that you can get your account opened before the end of the year. That way, you will have the benefit of professionally managed convertible bonds in your portfolio to start the New Year.

If you would like more information about the Wellesley Limited Risk Investing managed account program, give one of our Investment Consultants a call at 800-348-3601 or click on the following link to complete one of our online request forms.  I suggest that you call to find out if this investment may be suitable for your portfolio.

You can also find more information on the Wellesley managed accounts, including our latest webinar with Greg Miller, on our website at  As always, be sure to read the Important Notes below if you are interested in this investment.

Wishing you profits in uncertain times,

Gary D. Halbert

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IMPORTANT NOTES:  Halbert Wealth Management, Inc. (HWM) and Wellesley Investment Advisors ("WIA") are Investment Advisors registered with the SEC and/or their respective states.  This report does not constitute a solicitation to residents of any jurisdiction where the program mentioned may not be available.  Information in this report is taken from sources believed to be reliable but its accuracy cannot be guaranteed.  Any opinions stated are intended as general observations, not specific or personal advice.  Please consult a competent professional and the appropriate disclosure documents before making any investment decisions.   Investments mentioned involve risk, and not all investments mentioned herein are appropriate for all investors.  HWM receives compensation from WIA in exchange for introducing client accounts.  For more information on HWM or WIA, please consult the respective Form ADV 2 for the Advisor, available at no charge upon request. Officers, employees and affiliates of HWM may have investments managed by Advisors discussed herein and others.

For all years up to and including 2009, this presentation reflects only the convertible securities portion of WIA's client accounts.  Returns are based on all securities held in accounts of all WIA clients and the Miller Convertible Fund during the periods reflected.  Actual client accounts may include positions other than convertible securities.  Such other positions are not included in this performance presentation.  Accordingly, the actual return of WIA client accounts is different, in some cases substantially, from the performance information presented for convertible securities.   

WIA's convertible returns during this period have been calculated using the following methodology.  Such methodology includes several assumptions that results from systems limitations on aggregating the convertible security portion of multiple client account.  Returns do reflect the reinvestment of interest and dividend income, but do not reflect transaction costs. The security’s market value on the last day of the month is determined as is the weight of each security in the portfolio (individual security value/total security value).  Each security's return for the month is calculated (monthly interest earned plus/minus monthly price change).  It was assumed that the security entered the portfolio on the first day of the month in which it was first purchased.  When a security is completely sold out of a portfolio, the prior month-end value is adjusted to reflect the final sales price. Each security's return for the month was weighted by the security's weight in the portfolio.  The security’s weighted returns for the month were summed to get the portfolio's return for the month.  These numbers were compounded to calculate the annual returns.

For all years starting in 2010 and after, performance numbers were calculated in accordance with Global Investment Performance Standards (GIPS).  The monthly returns are size-weighted average returns and are compounded to calculate annual returns.  These performance numbers have not been audited yet and are not GIPS compliant.  Performance numbers include all accounts valued at least $250,000 and consisted of only cash and/or registered convertible securities.  Accounts with 144A non-registered bonds were not included in this presentation. Performance measurement for clients generally began on the last day of the month the account had at least $250,000 of value, consisting of only cash and/or registered convertible bonds.  However, clients who started with less than $250,000 were included in this presentation once the total account value of their cash and registered convertible bonds maintained a level of greater than $250,000 for 6 months.  Performance measurement for clients generally ended on the first day of the month in which the client account either terminated or held managed positions other than cash and registered convertible bonds.   Clients whose account started with at least $250,000 of cash and registered convertible bonds were excluded from the presentation once their total value of cash and registered convertible bonds remained below $250,000 for 6 months.  

The illustration, “$500,000 Investment at Inception with Flat-Dollar Annual Withdrawals and 3% C.O.L.A.” is hypothetical.  It is based on WIA Convertible Bond Returns, hypothetical $500,000 investments in WIA, and end of year withdrawals equal to flat dollar annual withdrawals with a 3% C.O.L.A.  No actual WIA client received these exact returns or withdrew these exact amounts.  There are inherent limitations in using hypothetical results, particularly the fact that such results do not represent actual trading, and that they may not reflect the impact that material economic and market factors might have had on the adviser's decision-making process if the adviser were actually managing client money. 

When reviewing past performance records, it is important to note that different accounts, even though they are traded pursuant to the same strategy, can have varying results.  The reasons for this include: i) the period of time in which the accounts are active; ii) the timing of contributions and withdrawals; iii) the account size; iv) the minimum investment requirements and/or withdrawal restrictions; and v) the rate of brokerage commissions and transaction fees charged to an account. There can be no assurance that an account opened by any person will achieve performance returns similar to those provided herein for accounts traded pursuant to the Wellesley Limited Risk trading program.

In addition, you should be aware that (i) the Wellesley Limited Risk trading program involves risk; (ii) the Wellesley Limited Risk trading program’s performance may be volatile; (iii) an investor could lose all or a substantial amount of his or her investment in the program; (iv) Wellesley will have trading authority over an investor’s account and the use of a single advisor could mean lack of diversification and consequently higher risk; and (v) the Wellesley Limited Risk trading  program’s fees and expenses (if any) will reduce an investor’s trading profits, or increase any trading losses.

Past performance is not indicative of future results.  The performance presented may not be representative of investments held in any client account or performance realized in any one client's account.  An investment in convertible securities involves a risk of loss.  Returns reflect the deduction of a 1.75% annual management fee, which is deducted monthly.   Fees are deducted quarterly in actual client accounts.  The value of an investment in convertible securities may decrease as well as increase. Performance does not reflect the effects of taxation, which results in lower returns to taxable investors.  Consult your tax advisor.  “Annualized” returns take into account compounding of earnings over the course of an investment’s track record.

As benchmarks for comparison, the Standard & Poor’s 500 Stock Index and the Bank of America/Merrill Lynch All Convertibles Index (both of which include interest and dividends) represent unmanaged, passive buy-and-hold approaches.  The volatility and investment characteristics of the S&P 500 or the Bank of America/Merrill Lynch All Convertibles Index may differ materially (more or less) from that of the Wellesley Limited Risk program, and these Indexes cannot be invested in directly.  The performance of the S & P 500 Stock Index and the Bank of America/Merrill Lynch All Convertibles Index is not meant to imply that investors should consider an investment in the actively managed Wellesley Limited Risk program as comparable to an investment in the “blue chip” stocks that comprise the S&P 500 Stock Index or the Bank of America/Merrill Lynch All Convertibles Index, which is broadly representative of the U.S. convertible securities market, consisting of publicly traded issues of all credit qualities, and excluding mandatory (equity-linked) convertibles. Statistics for "Worst Drawdown" are calculated at month end.  Drawdowns within the month may have been greater.  The returns reflect the reinvestment of interest income and dividend income. The results shown are for a limited time period and may not be representative of the results that would be achieved over a full market cycle or in different economic or market conditions.

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Forecasts & Trends E-Letter is published by Halbert Wealth Management, Inc. Gary D. Halbert is the president and CEO of Halbert Wealth Management, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, Halbert Wealth Management, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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