Convertible Bond ETF (CWB) Under The Microscope

by on February 23, 2010 | ETFs Mentioned:

Fixed income investments are a crucial component of any well diversified portfolio. Depending on investor age and time until retirement, most financial professionals recommend that at least half of your portfolio to be in fixed income securities, mostly low risk government bonds and high quality corporate securities. Yet, with yields hovering around zero and choppy equity markets as of late, some investors are seeking a third option, a middle path between equities and fixed income.

One middle path is convertible bonds, which are often seen as hybrid securities offering investors characteristics of both debt and equity markets. As ETFs have grown more popular, the ease and availability of investing in these types of instruments have grown immensely. A popular way to access these securities is with the SPDR Barclays Capital Convertible Bond ETF (CWB). CWB follows the Barclays Capital U.S. Convertible Bond >$500MM Index, which tracks the market of U.S. convertible bonds with outstanding issues greater than $500 million.

Convertible Bonds 101

Convertibles offer the best of both worldsConvertible bonds are basically corporate debt that can be converted into common stock of the issuing company, sometimes subject to certain restrictions. This unique aspect of these bonds allows companies to pay a lower interest rate than they normally would have to, but allows individual investors to maintain higher potential for price appreciation should equity prices rise. For this reason, convertible bonds tend to exhibit a stronger correlation with equity markets than bonds, and may not make great investments for investors who are seeking ETFs that are uncorrelated to their equity holdings. According to a Merrill Lynch study “converts provided 70% of the upside potential of the common stock, on average, while providing much higher protection on the downside, as the price of convertibles demonstrated smaller losses than the stock in all but one month over the study’s duration.” This suggests that while these types of securities are generally correlated with their underlying equity shares, they offer investors a safer alternative that might be ideal in shaky markets.

There are some obvious downsides to convertible bonds as well. Should equity markets sink, it could leave  investors out-of-the-money with no hope of converting into equity. Furthermore, some convertible bonds have a ‘mandatory’ conversion feature forcing the owner to convert the bond into stock no matter what the price is at the end of the bond’s life. As with all assets, there is a trade-off between risk and reward. For a more thorough introduction to convertible bonds, see this article.


The vast majority of the holdings in CWB consist of securities directly at or below investment grade; only 19% are rated “A’”or higher. Roughly a quarter of the 111 holdings consist of consumer non-cyclical bonds, with 21% allocated to technology and 16% to financial firms. The top holdings include Ford Motor convertible bonds due in 2016, perpetual Wells Fargo convertible bonds, and Citigroup convertible bonds due in 2012. The maturity breakdown is spread across the spectrum: about 20% of holdings are due in less than two years and 7% are due more than 30 years from now.

Returns And Fees

Over the last year, CWB has underperformed the S&P 500 but outpaced most bond funds, posting a gain of 23%. In addition to its price appreciation, the fund pays out monthly distributions and has a current yield of 3.86% (a 30 day SEC yield of 2.82%) while charging an expense ratio of 40 basis points. For a further look at convertible bonds, consider reading this article from SPDR (PDF).

For more ETFs in focus, see our previous under the microscope article. For more ETF news, make sure to sign up for our free ETF newsletter.

Disclosure: No positions at time of writing.