Because Europe has the most well-established convertible bond market outside the U.S., its issuers account for half of the international part of the portfolio. But the fund also invests in emerging markets such as Malaysia through convertibles such as YTL Corporation. A diversified conglomerate with holdings in industries such as electric utilities and property development, YTL represents "a proxy for Malaysia's growing economy," says Ofer. "It's a way to get exposure to that growth with less risk than the stock."
Whether it's on the domestic or international side, the managers look for the stable and improving credit quality of the issuer first, and equity characteristics second. "Most convertible bond investors come from the stock side of the business and get their ideas from equity analysts," he says. "We approach things from a bond perspective first, then look at the potential for capital appreciation."
Keele typically buys bonds when they are selling between 90% and 115% of par value. He considers a moderate conversion premium in the 25% to 35% range as a sweet spot that offers an optimal mix of potential for appreciation and a reasonable yield.
He also maintains a strict sell discipline. If a bond rises dramatically because the underlying stock has done well, it will lose its fixed-income characteristics, including an attractive yield, and offer little or no downside protection. At that point, Keele will likely sell.
"When a bond starts going into the 140s, we will start moving out of the position," he says. "Once it's reached the 170s or 180s, we're usually out." He will also sell if a stock goes down significantly, the convertible becomes too bond-like or its upside potential becomes too muted.
With its conservative, middle-of-the road strategy, the fund typically outperforms its peers in down-to-sideways stock markets. Keele says returns are about average in up markets but can lag at times when the equity markets rise rapidly, as they did in 2009.
The portfolio's most recently reported turnover rate of 106% is unusually high because a number of holdings shot past the fund's price targets during 2009's strong bull market. Keele anticipates that turnover will be lower going forward unless another strong market takes hold and the bonds reach their pricing targets sooner than expected.
A number of holdings, such as SBA Communications, have been in the portfolio for a year or more. The convertible bond of the cellular tower operator, which has a coupon of around 2% and matures in 2013, became part of the portfolio two years ago. Although the stock didn't do much in 2010, it has been showing signs of life this year.
"SBA generates high cash flow and is a play on the build-out of the cellular industry," he says. "This is a good example of using a convertible to get paid to wait for good things to happen with the stock."
Late last year, Keele began paring the fund's position in Ford as the convertible reached its pricing target, and replaced it with more attractively valued General Motors convertible preferred stock. "This is a way to reinvest in the automobile industry with a company that should do well over the long term," he says.