Convertible Securities

Convertible securities are part bond and part stock. In today's uncertain financial climate, they can be a sensible buy provided you are an experienced investor.

A convertible is a bond or preferred stock that pays a fixed rate of interest or a preset dividend. And it has a unique advantage: it can be exchanged for the issuing company's common shares if and when they rise to a certain price. So an investor in convertibles might have it both ways. He collects high interest or dividend income now and maybe he pockets big profits later on by converting into the common stock.

But you must pay a price for this flexibility. The cost of a convertible is higher than the value of the stock you can exchange it for. Also, the interest or dividends you collect on a convertible are usually three or four percentage points below what you can get on the same company's bonds or preferred stock.

If the issuing company's common stock rises steeply, a convertible reaches what is called its conversion price. It then pays to switch into those common shares and earn a profit. But what if the stock market goes down? The convertible is still attractive because it usually holds its value better than the common stock will.

Gerald Appel, editor of Systems and Forecasts newsletter, says that the ideal convertible is one that costs about $ 1,000, pays you 71/2% to 8% in interest and costs you only 10% to 12 % more than the value of the common stock that you can switch it into. Such a convertible will tend to keep pace with the common stock in an up market and fall only half as fast as that stock will in a down market.

You might also consider convertible bond funds. They usually pay about as much interest as money market funds do. But since you can trade in the bonds in a fund for stocks, you can still reap big gains when stocks start to rise again.

Convertible bond funds are less risky than stock mutual funds, in part because bonds are safer than stocks. The total returns of convertible bond funds for the year ending June 30, 1989, averaged 10.22%. The best performer was Convertible Securities and Income. It returned 28%. Three other funds that did well were Pacific Horizon Convertible, with a return of 21.1%, American Capital Harbor Fund, with a return of 18.8% and Heritage Convertible Income Growth Trust, with a return of 17.7%.