Convertible Securities
Instruments, portfolio strategies and valuation from the best-known convertible manager.
Summary
John Calamos, who founded the investment firm specialising in these instruments, wrote a practitioner reference on convertible securities covering valuation, analysis and portfolio application.
The instruments covered include convertible bonds, convertible preferred stock, mandatory convertibles, and the structured variants including zero-coupon convertibles and exchangeable securities where the conversion is into a different company's shares.
The analytical framework treats a convertible as a combination of components. The investment value is what the security would be worth as straight debt or preferred given the issuer's credit and prevailing yields, which sets a floor. The conversion value is the market value of the shares receivable on conversion. The premium over conversion value and the premium over investment value together describe the security's position, and the ratio between the two determines whether it behaves more like a bond or more like a stock. Calamos develops measures for this including the break-even period, meaning how long the yield advantage takes to recover the conversion premium.
The portfolio argument is that convertibles as an asset class have delivered equity-like returns with lower volatility, because they participate in a substantial share of upside while the bond floor limits downside, and that this makes them useful for investors who want equity exposure with reduced drawdowns. He supports this with long-run return data on convertible indices.
He also covers the arbitrage application, the credit analysis required, and the specific risks including issuer calls that force conversion at unfavourable times.
The long-run return claim depends on the index construction and on the period measured, and convertible performance has varied considerably by cycle. The book is a practitioner reference from 1998 and market structure has developed since, particularly with the growth of hedge fund participation which changed how convertibles are priced at issue.
Key takeaways 7
- A convertible's investment value as straight debt sets a floor, and the conversion value tracks the equity, with the premiums between them describing its behaviour.
- A convertible trading near its investment value behaves like a bond while one trading near conversion value behaves like a stock.
- The break-even period measures how long the yield advantage takes to recover the conversion premium paid.
- Convertibles have historically delivered equity-like returns with lower volatility because they capture upside while the bond floor limits downside.
- Issuer call provisions can force conversion at times unfavourable to the holder, which caps the upside.
- Credit analysis matters because the bond floor that limits downside depends entirely on the issuer's ability to pay.
- Hedge fund participation changed how convertibles are priced at issue, which affects the historical return comparison.
Who should read it
Investors considering convertibles as an asset class who want the valuation framework and the case for their risk and return profile.
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