Kensington Analytics LLC. Convertible Income Strategy

Transcription

1 Kensington Analytics LLC Convertible Income Strategy

2 Investment Process About Convertible Bonds Coupon income tends to instill some level of downside price resilience on convertible bond prices. This explains why they behave in a somewhat more defensive manner relative to the movement of traditional stock market indices such as the Dow Jones Industrials, S&P 500 or NASDAQ Index. Convertible bonds are hybrid securities that blend the characteristics of both an equity and a bond. A convertible bond is a fixed income security with an embedded equity call option. This merger of equity and bond characteristics produces a security that can have a favorable and appealing risk-reward profile relative to pure equities. In volatile markets, the bond value of a convertible security tends to create something of a price floor. Investors benefit from coupon income while getting paid to wait for the capital gain potential of the equity conversion feature. Over long periods of time, these traits explain why the innate level of volatility in convertible securities is somewhat mitigated when compared to volatility levels seen in the broad stock market indices. At times when the stock market is performing well, the conversion feature of a convertible bond allows the holder to convert from the traditional bond format into equity, which can then increase in value, hence generating the potential for equity-like returns. 2

3 Investment Process About Convertible Bonds From Investopedia The straight bond value is the floor of a convertible bond. In effect, a convertible bond is a straight bond plus an embedded call option. The market price of a convertible bond is made up of the straight bond value and the conversion value, which is the market value of the underlying equity into which a convertible security may be exchanged. When stock prices are high, the price of the convertible is determined by the conversion value. However, when stock prices are low, the convertible bond will trade like a straight bond, given that the straight bond value is the minimum level a convertible bond can trade at and the conversion option is nearly irrelevant when stock prices are low. The straight bond value is, thus, the floor of a convertible bond. Investors are protected from a downward move in the stock price because the value of the convertible bond will not fall below the value of the traditional or straight bond component. Stating this differently, the bond floor is the value at which the convertible option becomes worthless because the underlying stock price has fallen substantially below the conversion value. Floor value can be determined even before the bond reaches maturity through a calculation. Adding the principal payment to the interest payments, or bond yield, that have been received and are expected until it reaches maturity will result in the floor value. That is the figure that can be used for comparison against the conversion value to assess the worth of the securities. Source: 3

4 The Nature of Convertible Securities Convertible Securities Recent Historical Characteristics A statistical review shows that convertible securities have marginally outpaced the S&P over the last 20 years while demonstrating measurably less volatility. Convertible Securities - Other Statistical Outcomes Over the last 20 years, convertible bond mutual funds have slightly exceeded the total return of the S&P 500. Convertible securities are incrementally more volatile and more equity-like than high-yield bonds, but are still on average approximately 43% historically less volatile then the S&P 500. Convertibles have slightly exceeded the total return of the S&P 500 with a beta of just.51 and a standard deviation of 3.42 versus 5.46 for the S&P. The worst drawdown for convertibles over the last 20 years has been %, which occurred during the global financial crisis of This compares favorably to the % decline in the S&P over the same period. 4

5 Overview Who should consider Convertible Income Bonds? Although this strategy is equity oriented, the overlay of Kensington s risk-mitigating quantitative methodology makes it significantly less volatile than a traditional equity market buy and hold approach. Convertible Income Strategy The KA Convertible Income strategy was designed to bridge the gap between the risk and return parameters of high-yield corporate bonds and traditional equity indices like the S&P 500. While Kensington s Managed Income strategy, which focuses on high-yield corporate bonds, has generated superb results for over 26 years, there are some investors who seek higher rates of return, either for their entire portfolio, or more frequently, in a sleeve (or portion) of their portfolio. This strategy is suitable for moderate risk investors who seek to capture the more substantial equity-like results that are attainable using convertible securities, with the added benefit of meaningful downside risk-mitigation. The strategy invests in the asset class through the use of 40-Act open-end mutual funds and ETFs (exchange traded funds). Convertible income funds tend to mirror the overall directional movement of the U.S. equity market. 5

6 Investment Process The Model Details Most risk-on asset classes can have higher or lower intrinsic levels of volatility, but in the end, they tend to share a high level of directional trend correlation. This means they tend to rise and fall together, but with differences in the degree of percentage change. Buy and Sell Signals for Convertible Income The Convertible Income strategy relies on the same decision model that is employed by KA s Managed Income strategy. That model is detailed in related KA presentations. KA models tend to focus on changes in the larger, primary trend and therefore have fewer signals than many other more traditional quantitative models. By focusing on changes in the underlying primary trend, these models discern key changes in the larger environment from risk-on to riskoff. High-yield bonds, convertibles, preferreds, REITs and traditional equities all tend to have high directional correlation and trend positively during favorable (risk on) climates. As a result, the same buy signals that work well with high-yield bonds also tend to produce timely points of entry in these other highly correlated asset classes. Like all of the KA strategies, Convertible Income s decision model is trendfollowing in nature, with important elements of counter-trend logic that can add value at critical market bottoms. 6

7 Investment Process The Model Details 40-Act mutual funds tend to be less volatile and deliver a smoother return stream over time, while ETFs provide greater intraday liquidity and also substantially lower fees. Convertible Income may employ a combination of these vehicles in its approach toward this market niche. Convertible Income Strategy Historic experience suggests average annual turnover of less than once per year, although turnover can rise in more volatile markets. The strategy employs the use of 40-Act mutual funds and Exchange Traded Funds (ETFs). Both of these vehicles offer daily liquidity. Mutual funds produce a smoother return stream over time. ETFs help reduce embedded fees and transaction costs, with the added benefit of intraday liquidity. 7

8 Performance Results Real Time Returns vs. Buy & Hold Benchmark Results are based on long trades only and assume a 100% allocation to money market and/or U.S. Treasury securities when defensive. Performance is net of a 1.5% management fee. Inception date December 31,

9 Statistical Metrics Risk Profile Robust statistics reflect solid performance enhancement through significant capture of gains during up markets with lower risk in down markets. KA Convertible Income ICE ALL Convertibles Index Standard Deviation 5.38% 8.87% Sharpe Ratio Maximum Drawdown -9.80% % Percent of Positive Months 69.39% 67.35% Compound Annual Growth Rate 4.30% 6.75% 9

10 Real Time Performance Statistics (After Fees) Performance Profile Moderating downside risk helps most investors to psychologically cope with risk, thereby helping them to remain invested in order to actualize longer-term returns. KA Convertible Income Performance After Fees JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC ANNUAL % 1.89% % -3.25% -0.28% 0.09% 0.11% -0.26% 0.13% 0.13% -0.27% -4.54% -2.01% 1.37% -7.14% % 2.46% -0.32% 1.12% 0.28% 0.85% 1.20% -0.24% 2.06% 0.77% 1.58% 0.28% 11.38% % 0.13% 4.93% 1.86% 0.73% 0.77% 2.88% 1.06% -0.04% -3.18% 2.01% -0.81% 10.63% % 1.20% 0.60% -1.75% 0.92% -0.37% 0.00% 0.00% -0.37% 0.00% 0.00% -0.37% 1.88% ICE Bank of America Merrill Lynch All U.S. Convertibles Index JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC ANNUAL % 7.05% % -1.16% 0.49% -0.20% 3.54% 0.42% 0.65% 3.52% -0.26% -6.04% 1.27% -4.68% 0.15% % 1.91% 0.64% 1.11% 0.70% 0.64% 2.02% 0.37% 1.34% 1.64% 0.12% -0.20% 13.70% % 0.25% 4.64% 1.46% 1.70% 0.43% 4.55% 0.28% 1.12% -1.66% 2.29% 1.50% 10.43% % 4.15% -0.32% 0.74% 2.28% -2.41% -0.35% -3.60% -3.33% 3.71% -0.77% -2.01% -2.99% 10

11 Management / Organization Management / Organization 11

12 CONTACT INFORMATION Additional information about the strategy or the adviser is available upon request KensingtonAnalytics.com 12

13 Disclosure Statement This presentation is neither an offer to sell nor a solicitation of an offer to buy any securities. Past performance is not indicative of future returns and the value of investments and the income derived from them can go down as well as up. Future returns are not guaranteed and a loss of principal may occur. The risks associated with this strategy include general market risk, credit risk, interest rate risk or risk of the portfolio not performing as expected. The types of securities held by a comparison benchmark may be substantially different from the investment strategy. An investor should consider the investment objectives, risks, charges, and expenses of the investment and the strategy carefully before investing. An investor should consider the investment objectives, risks, charges, and expenses of the investment and the strategy carefully before investing. No reliance may be placed for any purpose whatsoever on the information contained in this document or on its completeness. Kensington Convertible Income Strategy has an inception date of 12/31/2014. Kensington Analytics LLC is a d/b/a of Advisors Preferred, LLC. The name of the organization was formerly known as Kensington Asset Management until 09/24/2012. Benchmark: The Kensington Convertible Income Strategy is benchmarked to the ICE Bank of America Merrill Lynch All U.S. Convertibles Index. The types of securities held by a comparison benchmark may be substantially different from the investment strategy. An investor should consider the investment objectives, risks, charges, and expenses of the investment and the strategy carefully before investing. Performance figures provided reflect the deduction of a 1.50% annual investment advisory fee. Investment returns will be reduced by advisory fees and other expenses charged in the management of a client s account. You should carefully review applicable fees disclosed in Form ADV, Part 2. You should understand how ongoing advisory fees, compounded over a number of years, reduce the value of your investment portfolio, as investment balances and potential gains on the investment balances are reduced by fees. Additional information is provided in the SEC Investors Bulletin How Fees and Expenses Affect Your Investment Portfolio. Investment advice offered through Advisors Preferred, LLC, 1445 Research Boulevard, Ste. 530, Rockville, MD