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Investors have many options when it comes to investing in bonds. Usually, investors can get bonds directly from the issuer. These issuers may include municipalities, government agencies, or companies. On the other hand, investors can also invest in funds that offer convertible bond investments. Among these investments, investors can choose to include convertible bond funds in their portfolio.
What are Convertible Bonds?
Convertible bonds allow the holder to convert their bonds into the issuing company’s equity in the future. These bonds are a type of hybrid security that has characteristics of both debt and equity finance. The equity characteristic comes from the option to convert the bonds into equity in the future. The debt characteristic is inherent to the bond, similar to traditional bonds.
In essence, convertible bonds are debt instruments. It is because these bonds come with a face value, a maturity date, a coupon rate, etc. These are all characteristics that are common to all traditional bonds. The equity component is only applicable if the investor or bondholder chooses to convert their investment into equity.
Apart from the terms associated with traditional bonds, convertible bonds also come with conversion terms. These usually include the number of shares that investors can get for each unit of conversion. For example, a convertible bond may come with the option to convert each $100 of bond face value to 5 ordinary shares.
What is a Convertible Bond Fund?
Convertible bonds aren’t as common as other types of bonds. However, these are still significant as they consist of an element of both equity and debt. For investors, convertible bonds are important as these come with a call option. For the issuing company, convertible bonds mean a potential increase in future equity balances and dilution of control.
Stable companies don’t usually issue convertible bonds. Only companies that have a low credit rating but come with a high growth potential use convertible bonds. It makes identifying and investing convertible bonds complicated for convertible bond investors. Therefore, investors can simply invest in convertible bond funds.
Convertible bond funds represent a pool of funds from investors that want to invest in convertible instruments. These usually come in the form of mutual funds and have all the characteristics of mutual funds. However, the underlying investment for convertible bond funds is any bonds that come with a convert option.
What are the advantages and disadvantages of Convertible Bond Funds?
Convertible bond funds allow investors to focus their investments on convertible bonds only. Usually, there is a manager who manages these investments. Therefore, investors don’t need to manage their investments actively. Similarly, investors have the option to convert their bonds at maturity. It allows them to significantly increase their wealth if a company experiences growth during the bond period.
However, convertible bond funds come with some disadvantages. By allowing managers to manage these funds, investors lose control of their investment. Similarly, there are some fees and expenses associated with convertible bond funds. On top of that, convertible bonds usually come from companies that a low credit rating. Therefore, these can prove to be high-risk investments.
Conclusion
Convertible bonds are debt instruments that also have equity instrument characteristics. These are bonds that allow investors to convert their bonds into ordinary shares. Investors can pool their funds and invest in convertible bond funds. Usually, these are mutual funds that enable investors to invest in several convertible bonds.
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