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Your portfolio is not as diversified as you think, unless you are utilizing this powerful strategy



With historically low interest rates, investors are cramming money into stocks, especially in large-cap technology companies including Microsoft Corp. and Facebook Inc.

A simple way to diversify by asset class while cutting risk and benefitting from long-term stock gains is to own convertible bonds.

Dave King, the head of income and growth strategies at Columbia Threadneedle Investments in Boston and a co-manager of the $2.1 billion Columbia Convertible Securities Fund
 discussed the sea change in the convertible bond market brought about by the coronavirus, the advantages of the asset class and Tesla Inc.’s
ultra-profitable convertible bond deal.

Not so diversified

The largest exchange traded fund based on an index is the SPDR S&P 500 ETF
which has nearly $294 billion in assets and is weighted to track the S&P 500
This means shares of Apple Inc.
 and Alphabet Inc.
 make up 22% of the fund’s portfolio.

You might look to diversify further by shifting some of your portfolio s into foreign or emerging-market ETFs, but those may also be highly weighted to a small group of companies.

You can diversify your portfolio and even cut your risk is by holding shares in a convertible securities fund or ETF.

Some side benefits: attractive long-term growth potential, downside protection and a decent dividend yield.

You are probably well aware that the cap-weighting for the S&P 500 has worked to its advantage during the years following the post-credit-crisis bottom on March 9, 2009. But check out this 20-year chart through June 30, comparing the benchmark’s performance and volatility with that of the ICE BofA U.S. Convertibles Index and the Bloomberg Barclays U.S. Aggregate Bond Index:

Columbia Management Investment Advisors, LLC, with data provided by ICE BofA and Zephyr Style Advisor.

The convertibles came out ahead of the S&P 500, with lower volatility, measured by standard deviation.

Most of the gains with less risk

A convertible bond is one that can be converted into the issuing company’s common shares at a stated price or ratio per $1,000 borrowed. Preferred shares can also be issued with convertible features.

An example of a convertible issue was provided by Workhorse Group Inc.
 on Oct. 12.

The manufacturer of electric delivery vehicles issued $200 million in 4% convertible notes to institutions. The notes mature in four years and can be converted to common shares at a price of $36.14, which is a 35% premium to the stock’s closing price Oct. 9. In an interview, King said a 4% yield with a maturity of five years or less was typical of the current market for high-yield bonds, or junk bonds — those with ratings below BBB.

Some high-yield bonds aren’t rated at all. In that market, King explained, the unrated paper is considered “nuclear waste.”

But in the convertible market, “it is common for companies not to be rated. Often they are not rated because a company has traditionally had no debt. This is not commonly understood,” King said.

He added that the market’s lack of understanding of convertibles, or even the lack of patience among some investors to wait for a share price to rise after buying convertible bonds, creates opportunities for him to scoop up convertibles at attractive prices.

So the institutional investors who bought Workhouse’s new convertible notes are paid nicely as they wait for the share price to climb. That 4% bond coupon compares to a yield of only 0.34% for five-year U.S. Treasury notes
If Workhorse’s stock rises above the conversion price, the lenders can then convert their notes to common shares. Or they can sell their notes to other investors at much higher prices, because the market value of the bonds will move higher as the stock price rises.

If the stock falls or never rises above $36.14, the lenders will have what King called “a bad investment.” But it will be nowhere near as bad as things may have looked March 23, when the S&P 500 was down 37% from its closing high Feb. 19. Or on March 9, 2009, when the S&P 500 was down 57% from its pre-crisis closing high Oct. 9, 2007. A 4% annual yield while getting your money back provides a solid cushion within a portfolio, especially if you are waiting for a deflated market to recover.

The big risk faced by Workhorse’s convertible bondholders is that the company goes bankrupt before the four years have passed. The institutional investors obviously don’t expect that to happen. They have gotten a good interest rate, unlimited upside potential and downside protection in return for that risk.

Tesla has dominated the convertible bond market

On May 3, 2019, Tesla Inc.
 issued $1.6 billion in 2% convertible notes that mature in May 2024. The conversion price was $309.83. Tesla completed a five-for-one stock split on Sept. 1. So if we adjust for the split, Tesla’s closing share price Oct. 9 would be $2,170. That’s a tidy profit for the convertible-bond holders in less than a year and a half. Plus interest.

King said that the next time Tesla wishes to borrow, it will probably not have to offer convertible bonds because investors have gotten more comfortable believing in the company’s long-term viability.

But things were different in May of last year, because the company’s previous bonds without the conversion feature “immediately went to a discount when issued.”

In other words, as soon as the underwriters and institutions snapped up the bonds, they would have taken losses if they had decided to sell them. Tesla was focused on investing any cash flow it generated into growing production, rather than showing a profit. So the market applied a 15% discount to the bonds quickly, King said.

A watershed year for convertibles

Before 2020, King said there was “essentially no growth” of the convertible bond market for more than a decade. That changed completely this year, with nearly $100 billion in new issuances as COVID-19 forced a partial economic shutdown, he said.

Many companies that weren’t debt issuers were forced to sell convertible bonds to short up cash. King cited Dick’s Sporting Goods Inc.
 as an example. In April, the retailer sold $575 million in 3.25% convertible notes due in 2025, with a conversion price of $35.38. The stock closed at $60.76 on Oct. 9.

So convertibles are often issued to fund rapid growth by companies that haven’t yet been accepted by the market as regular issuers of debt (as was the case with Tesla and now Workhorse), or as “rescue capital” by companies in unusual circumstances, such as Dick’s Sporting Goods, or to fund acquisitions, King said.

When asked about typical convertible investments outside the coronavirus-crisis environment, King pointed to “emerging growth companies,” in industries such as biotech, software-as-a-service or even “one-off hypergrowth companies such as Nvidia
 that hit the growth inflection point and realize they need to be a real company and need a bunch of money.”

Fund performance

The Columbia Convertible Securities Fund is rated four stars (the second-highest rating) by Morningstar. The total return for 2020 through Oct. 9 for the fund’s institutional shares
 was 29.7%. The Tesla 2% convertible notes made up 7.4%% of the portfolio, according to FactSet.

The SPDR Bloomberg Barclays Convertible Securities ETF
 was up 30.9% for 2020 through Oct. 9, with the Tesla 2% convertible notes making up 5.1% of its portfolio.

But for longer periods, the Columbia Convertible Securities Fund has performed better than the ETF, even though it has higher annual expenses of 0.88% of assets under management compared with an expense ratio of 0.40% for CWB (scroll the table at the bottom to see all the data):



Average annual return – 3 years

Average annual return – 5 years

Average annual return – 10 years

Columbia Convertible Securities Fund Class I

US:NCIAX 17.9%



SPDR Bloomberg Barclays Convertible Securities ETF

US:CWB 16.2%



Source: FactSet

Even though the passive strategy has worked well, King stressed the importance of his firm’s active strategy for convertibles and how different teams of equity and income analysts work together on ideas, many of which are special circumstances for issuing companies. He also said the market continues to be dynamic, with deals often announced and completed the same day.

Other large holdings of the Columbia Convertible Securities Fund listed by FactSet include:

• Zillow Group Inc.
 2.75% notes maturing in May 2025.
• Coupa Software Inc.
 0.375% notes due in June 2026.

• Danaher Corp.
 5% mandatory convertible preferred stock, Series B due April 15, 2023.

• Microchip Technology Inc.
 2.25% notes due in Feb. 2037.

Read:Get ready for a good earnings season for big U.S. banks

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‘I could live on my Social Security and still save money’: This 66-year-old left Chicago for ‘calming’ Costa Rica — where he now plans to live indefinitely




Editor’s note: This article was first published in September 2019.

A school break changed 66-year-old Martin Farber’s life forever.

In 2007, his daughter — who at the time was attending Illinois State University — decided she wanted to spend a college holiday volunteering in Costa Rica and staying with a local family, he explains. She came home raving about the experience, so, in 2008, Farber — who at the time was living in Evanston, Ill., just outside Chicago, and selling cars — took his first trip there.

“It was a big surprise to me — bumpy roads, dogs barking in the streets,” he says. “I wasn’t enamored at first.”

But as his daughter began traveling there more and eventually moved there for a year, he took additional trips to Costa Rica. It quickly grew on him — in particular, the people. “The Costa Rican people are warm, open and friendly. I felt less invisible in a strange country in a strange town where I didn’t speak the language than I did in Evanston.”

And the more time he spent there, the more it impacted him: “On one of my trips there, I thought: My daughter’s life makes more sense than mine,” he says. “There was nothing wrong with my life, but I felt that my life was out of context with who I’d become. … I would have bills and make money to pay them, but that had ceased to be satisfying,” he recalls. “I knew I needed to change my life — there was no more joy in what I was doing.”

What’s more, when he’d return from his Costa Rica trips, people noticed. “I would come back, and my friends and therapist would say: You seem better after you go,” he says with a laugh.

A view from the hot springs near Martin Farber’s home in Costa Rica.

Martin Farber

So in 2014, he packed up and moved to Orosi — a picturesque, lush small town with waterfalls and hot springs a little over an hour’s drive from San Jose — promising himself he’d stay for two years. It’s been five, and he now plans to stay in Costa Rica indefinitely. (Though Farber notes that, to him, “it’s not a retirement; it’s a chance to lead a new and different life.”)

Here’s what his life is like, from costs to health care to residency to everyday life:

The cost: While many expats spend way more living in Costa Rica, Farber says: “I could live on my Social Security and still save money.” He says “a person can live on $1,200 per month, two people on $2,000.” The key, he says, is to live more like he does and as the Costa Ricans do — in a modest home, eating local food and purchasing local goods.

Indeed, Farber himself spends just $300 a month for rent (he rents a home from a friend who moved recently and gave him a good deal), roughly $225 a month on groceries and just $50 a month total on water and electricity (the temperate climate in Orosi means you rarely need heat or air conditioning). The veteran Volkswagen


salesman saves money by not owning a car (those over 65 ride municipal buses for free), which can be a significant expense in Costa Rica; for his cellphone, “I pay as I go … roughly $10 may last me a couple weeks or more,” he says, adding that “many people handle there their cellphones this way. You can get them recharged anywhere.”

His major expense is travel: He goes back to the U.S. to visit his mother in Florida several times a year and lately has spent part of the summer in Chicago helping out a friend with a dealership there. He also spends a good amount of money on health care. He says that while flights can be had for as little as $350 roundtrip during offseasons, the cost can be much higher the rest of the year.

In the saddle.

Martin Farber

Health care: Farber, who has permanent resident status in Costa Rica, says he pays about $90 per month to participate in the country’s health-care system — adding that the health care he’s received has been very good. (A 2018 study of health-care quality and access in more than 190 nations ranked Costa Rica No. 62.)

When he developed a detached retina, though, he paid for the procedure out of pocket so that he didn’t have to wait for the required surgery, he says — adding that the entire procedure cost him about $5,000. “I would have had to have waited four days,” he says, if he had not paid to expedite matters. “That might have been fine, but it might not.” And he adds that the quality of care depends on where you get it in the country.

Lifestyle: Though Farber says that he “moved here with no goals and no agenda,” he’s found plenty to do. “I take Spanish lessons two days a week for two hours a day. It’s been great. I never thought I would acquire a usable language in my 60s,” he says. He also rides his bike all around the area, does some writing and belongs to a community group that undertakes projects to improve the area.

And he often simply takes in nature, which he says has been an essential part of why he feels calmer and more relaxed in Costa Rica than in the U.S. “I live at 3,000 feet but in a valley surrounded by coffee fields and lime trees and water. At night, if I open the windows, I can hear the river rushing by,” he says. “It is very calming … hundreds of trees everywhere … you know the Earth is alive.”

The historic Iglesia de San José de Orosi.


Cons: “I don’t want to overglorify. It’s not without its problems,” Farber says of Costa Rica. “There are social problems and downsides.” He notes that crime and petty theft can be a problem (“I am cautious,” he says of his approach) and seem to have increased since he moved there, and adds that he misses out on some cultural things because of where he lives. And, he says with a laugh, “I can’t order Thai food at 9 at night.” But, he adds: “These are trade-offs — in the afternoon, I get to walk in the coffee fields and see flocks of parrots.”

Residency: To qualify for Costa Rica’s pensionado visa, expats must prove that they have a pension of at least $1,000 coming in each month. (Here are the details of that program.) Once you have lived in Costa Rica for three years, you can apply for permanent residency. Farber used a lawyer to help him figure out the ins and outs of residency options; his entire path to permanent residency took about a year, he says.

The bottom line: “After five years I am still amazed and surprised that I made the decision to lead a life I never thought I would,” he says. And while he may not stay in Orosi forever — “the town doesn’t have an ambulance, [and] I don’t know what it will be like to be 80 there,” he says — he does plan to stay in Costa Rica in no small part because of the people and sense of community. “I have the feeling that life is good here,” he says. “It’s hard sometimes, but we are all in it together.”

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Mutual Funds Weekly: These money and investing tips can help you read the market’s signs and stay on your path




These money and investing stories were popular with MarketWatch readers over the past week.

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Mutual Funds Weekly: These money and investing tips can help you read the market’s signs and stay on your path




These money and investing stories were popular with MarketWatch readers over the past week.

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