Editor’s Note: Over a week ago, Alexander Green recommended subscribers take a look at convertible bonds. They represent a way to hold income securities with some positive equity exposure. It fits in perfectly with our asset allocation portfolio, since we recommend 10% in high-yield bonds and 10% in high-grade bonds. We’ve excerpted his article because we feel there isn’t enough being said about these investment vehicles. Take a look…

Stocks are beginning to move again – the Dow rose over 6% last week alone – but many investors are skeptical of how long the rally will last. Already the market has pulled back.

As I describe in the January Communiqué, I believe this will be a good year for stocks despite the economic downturn.

But if you’re feeling a little gun shy after last year’s rollercoaster ride, there is a second-best alternative: convertible bonds.

Convertibles are corporate bonds that can be converted into shares of the issuing company. At the time a convertible is created, the company spells out exactly the number of shares that can be converted, the price at which the conversion can occur and the time frame.

Typically, convertible bonds have a lower coupon rate than ordinary bonds. But since the holder is given the right to convert the bond into common stock – often at a substantial discount to the shares’ current market value – they offer superior upside potential.

Convertible Bonds – More Conservative Than Stocks

Convertible bonds are more conservative than stocks because they represent a senior claim on the company and will pay interest even if the underlying stock doesn’t rise. And they are more aggressive than ordinary bonds because a drop in shares of the issuer can negatively affect them.

If the underlying stock rises, however, the bond will climb along with it. So, in essence, you have the safety of a bond combined with the appreciation potential of equities.

Like virtually every asset class (with the exception of Treasuries and gold bullion), convertible bonds had a tough year in 2008. Why? Both corporate bonds and common stocks fell sharply.

But convertible bonds now represent excellent value, especially for investors who are only tiptoeing back into the waters.

For this reason, you should consider buying or adding shares of convertible bonds to your investment portfolio.

Good investing,

Alexander Green
Investment U