Insulation from Volatility
Essentially, there are three reasons to buy a convertible security rather than a common stock.  First, convertibles yield more, usually a great deal more.  Second, convertible securities are higher in quality, and third, their price movements are generally far less volatile.  Moreover, given an equal move up or down in the price of the underlying common stock the convertible security will go up more than it will decline.  Whenever the stock market averages experience sharp and significant declines over a short period of time we calculate the returns of our convertible bond holdings relative to those of the major stock averages.  Between October 31, 2007, and the end of trading on February 29, 2008, the S&P 500  declined 11.94%.  The Dow Jones Industrial Average fell 14.52% and the NASDAQ composite dropped 20.55%.  In contrast, the convertible bond holdings of client portfolios managed by Carr & Associates exhibited little sensitivity to these declines. The convertible bond positions in Carr & Associates clients' portfolios declined just 1.72%,on average, although their underlying common stocks fell by 8.99%, on average.  Over the 18+ years since the inception of Carr & Associates, client portfolios have, on average, captured 70% of the gains in the S&P 500, measured on a monthly basis, and participated in none of the declines. 

While past performance is not necessarily indicative of future results, these kinds of results in market downturns have been typical in the past.

A much more dramatic example is shown below.  On Monday, September 10, 2001, we had prepared a table showing comparisons over the period August 24 through September 7, 2001 when the Dow Jones Industrial Average, the S&P 500 and the NASDAQ were down 7.84%, 8.37% and 11.95%, respectively.  Then, on Tuesday morning, September 11, in unbelieving horror, we watched the destruction of the World Trade Towers.  The reopening of the equity markets on Monday, September 17, provided the equity markets with the first opportunity to react to the terrible events of September 11. Stocks continued to fall and, by the end of the week, had reached selling climax levels.  The Dow Jones Industrial Average had recorded a four-week fall of 20.99%.  The S&P 500 and the NASDAQ were off 18.49% and 25.75% respectively over the August 24 - September 21, 2001 period.  Once again, our convertible portfolios held their value well, with the bond portfolios declining just 4.60%, on average, although the common stocks of these issues were down 20.07%, on average.  The 10 largest positions, shown below, were off just 2.78% on average, while their common stocks dropped 14.15%.