ICTV: A Hybrid Bond Instrument for Portfolio Diversification

First, the iShares Convertible Bond ETF (ICVT) is not just another bond fund. For this matter, convertible bonds have demonstrated low correlations to traditional bonds, such as the Vanguard Total Bond ETF (BND) which, as per the blue chart below, has taken a beating as the economy recovered. On the other hand, ICVT, despite not offering the same gains as the S&P 500 during 2021, has profited from the recovery.  As such, it can potentially provide attractive diversification benefits within a broad equity-bond portfolio.

Source: Trading View

For those who are new to the subject, when an investor owns a convertible bond, she perceives interest payments just like for a fixed-income corporate debt security, but with the added advantage that it can be converted into a predetermined number of common stock (equity shares). In the particular case of ICTV, the fund primarily owns bonds of the technology sector at 43.5% of its total portfolio (as of January 3) followed by Consumer Cyclicals (19.9%). It also owns convertible bonds from the Consumer Non-Cyclicals and Communications sectors as shown below.

Source: iShares.com

Going deeper, with 343 holdings, and the weight of each individual holding not exceeding 3%, ICVT follows the Bloomberg U.S. Convertible Cash Pay Bond > $250MM Index. These are basically companies exceeding the 250 million dollars market cap. The first ten companies are shown above.

The fund managers charge an expense ratio of 0.20% and pay dividends yielding 0.90% (30 day SEC yield). This is not much when compared to dividend-paying ETFs providing for over 4% yields, but, the rationale for owning convertible bonds is not high income. Rather, they are uniquely positioned to offer the growth potential of stocks, but with some level of income, and, more importantly, they offer the downside risk management characteristics of traditional bonds.

Going a step further, in a rising rates environment stocks tend to outperform bonds since a convertible bond’s price is influenced by the value of its underlying equities. Hence, with rates rising in 2022, ICVT should be less susceptible to changes in interest rates compared to other fixed-income asset classes. Thus, looking at the longer term, with over 1.6 billion of net assets since inception in June 2015, the fund has attracted investors wishing to get exposure to “hybrid” securities, or those that have both equity and debt features.

Finally, scanning the ETF space for peers, I came across the SPDR Series Trust – SPDR Bloomberg Barclays Convertible Securities ETF (CWB) and the Calamos Convertible and High Income Fund (CHY), but I still prefer ICVT because of its lower expense ratio together with the fact that it is currently available at a discount of -0.48% to NAV, making it an opportunistic investment.