These have been trying times for buyers of convertible securities, says Theodore T. Southworth, who runs the US$204 million Northern Income Equity fund.
Ideally, convertibles -- bonds or preferred shares that can be converted to common shares at a predetermined exchange rate -- will account for all of the fund's holdings, he said.
But he has reduced that proportion to 76 percent because few convertibles have been issued recently and there are fewer good buys available, he said. At the moment, stocks account for 10 percent of the fund's holdings, and cash represents 14 percent.
He said that he believes that the supply of convertibles would remain tight because financial markets are still unsettled.
"Companies haven't yet reached the point where they're looking for money for general corporate purposes," he said.
The fund lost 0.5 percent a year, on average, for the three years through Thursday, compared with a 5.2 percent loss for all convertible bond funds, according to Morningstar. The Standard & Poor's 500-stock index fell at an annual rate of 13.5 percent in that period.
The fund declined 3.3 percent in the 12 months through Thursday, compared with losses of 6.5 percent for its group and 22.9 percent for the S&P 500, Morningstar said.
Southworth, 54, is a senior vice president of Northern Trust, which owns Northern Trust Investments, the fund's adviser.
Generally, he said, convertible securities, which pay interest, give investors exposure to stock market profits but with less risk. His goal is to identify convertible issues with high potential for gains.
He picks the fund's 80 or so convertibles mostly from among about 600 domestic convertibles whose underlying common stock has good earnings growth potential and sells for reasonable valuations.
While he reviews a company's fundamentals, including cash flow and earnings growth rate, he also pays attention to technical analysis -- the study of a stock's price movements -- over the last year or two.
When the price charts deviate from analysts' expectations, he said that he puts his faith in the charts, which reflect the actual behavior of the great majority of investors.
In April, Southworth bought a convertible preferred security due in May 2005 issued by Alltel, a regional phone company based in Little Rock, Ark. He paid US$49.81 for the issue, which yielded 7.75 percent; it closed on Friday at US$47.90. Because the issue is a "mandatory convertible," which must convert to common shares on a specific date, regardless of its stock price at the time, its price fluctuates more like a high-yielding equity than a bond, Southworth said.
It is unrated by Standard & Poor's but rated A2 by Moody's Investors Service, a midlevel investment grade rating. He expects annual earnings growth of 8 percent in the next three years.
He bought a 5.75 percent senior convertible note due in April 2007 and issued by Airborne Inc, in Seattle. He paid US$94.34 for the note in October, 2002; it closed on Friday at US$107.25. The issue is rated BBB- by Standard & Poor's, its lowest investment-grade rating.
"The stock was bumping along at US$10 because the market seemed to make the judgment that the economy would never recover," Southworth said. "We thought that we'd avoid a double-dip recession, and if the economy grows the transportation sector will have to participate."
He also owns a BB- rated subordinated convertible note due June 2006 issued by the Interpublic Group of Companies, the New York-based holding group of advertising agencies. Last summer, "Interpublic's stock price got clobbered when its earnings didn't meet expectations, and everyone worried about whether they can believe anything that management told us." he said.
He bought the issue before the SEC notified Interpublic in January that it was upgrading an informal inquiry into the company's accounting practices to a formal investigation.
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