Investors who want a little less octane in their equity exposure can turn to funds that combine stocks and other asset classes. Known as asset allocation funds, these multi-asset-class products offer equity exposure ranging from 20% to 90%, with the remainder in fixed income and cash.

One of the top funds in Morningstar’s moderately aggressive allocation category has been the Calamos Growth and Income Fund. This category includes funds with portfolios typically containing 50% to 70% in equities, with the remaining portion in fixed income and cash.

The Calamos fund adds some pep to its fixed-income exposure by combining convertible securities with traditional fixed income, with a greater emphasis on the former. That, in tandem with an equity weighting that’s substantially higher than the category average, has helped make this fund’s institutional share class a top-quartile performer in its category in every measurable period from one to 15 years. Furthermore, Lipper this year named the Calamos Growth and Income Fund’s institutional share class as the best fund in its flexible portfolio fund category during the last five- and 10-year periods.

The fund’s use of convertible securities—along with a smattering of options strategies—creates what fund manager John Hillenbrand calls an asymmetric risk profile. He and his team aim to generate total returns higher than its Morningstar category with a lower volatility profile than the S&P 500.

According to Calamos, the fund’s investor share class has had a 0.69 beta to the S&P 500 over its history since inception in 1997. (Beta measures a security’s or portfolio’s volatility against the overall equity market, which has a beta of 1. An investment with a beta below 1 is less volatile than the market.) In addition, the fund since inception has sported a standard deviation of 17.82 versus 23.46 for the S&P 500. (Standard deviation gauges volatility by measuring dispersion around an average. A lower value is better.) Meanwhile, the fund’s average annual returns since inception have topped the S&P 500, though it has trailed that index during the past 10 years.

“We’re trying to get a risk profile that’s 80 percent-ish of the S&P 500 by using those different asset classes which have different risk profiles from the S&P 500,” Hillenbrand says. “We’re targeting lower risk, and we can get there in different ways depending on short-term and long-term views of the markets.”

Convertibles
Calamos Investments has been using convertible securities since John P. Calamos Sr. founded the Naperville, Ill.-based firm in the 1970s. The company bills itself as the largest manager of convertible securities in the U.S. and the second-largest in the world.

“One of our first strategies was convertible arbitrage, and it has been part of our DNA to think about that asymmetric risk profile and prepare for future investment outcomes by mitigating potential downside risk while getting a little bit more return,” Hillenbrand explains.

Convertible securities combine attributes of both equities and traditional fixed income. A convertible is a debt instrument that can be exchanged or converted into a specific number of shares of the issuer’s common stock. They can offer upside appreciation in rising equity markets by capturing a portion of the underlying issuer’s capital appreciation. On the flip side, they can enhance yield by providing consistent income while offering potential downside protection when equities tumble.

Convertibles typically generate higher income than their underlying equity. The income portion of the fund’s portfolio—produced mainly from convertibles and traditional fixed income—generated a recent distribution yield of 4.15%.

“Historically, we’ve used more convertible bonds versus traditional straight fixed income in this portfolio,” Hillenbrand says about the Growth and Income Fund. “Today, they’re both probably below average, in part because of the opportunities we’ve seen in large-cap equities.”

Big Tech
As of the end of June, the fund’s top six holdings were Microsoft, Nvidia, Apple, Alphabet, Amazon.com and Meta Platforms. In other words, six of the seven so-called Magnificent Seven stocks that have disproportionately outperformed the overall U.S. stock market since last year. (Tesla, the seventh stock in this group, is a smaller position in the fund.)

This group of stocks began to stumble in this year’s third quarter as investors re-evaluated their prospects given the concerns about the companies’ valuations and doubts about whether the mania surrounding artificial intelligence was overhyped. Does that concern Hillenbrand?

“I’m always concerned about everything. That’s part of our ethos of trying to participate in the up while getting some protection on the down,” he says, noting that he and his team incorporate valuations into the overall framework of portfolio construction.

He argues that the valuations of these leading megacap companies aren’t egregious. “When we run them through our framework of great business models and competitive advantages and things like that, those stocks screen very well. That’s why we’ve owned them for quite some time.

“So I think they’re great long-term companies, but they don’t always work in every time period,” he continues. “And when we find things that are better, we’ll pivot our portfolio appropriately.”

While Hillenbrand is comfortable investing in the equities of certain big-tech names, he uses convertibles to dampen the perceived risk in other equity holdings. He puts those risks into two separate buckets. First there are straight-up cyclical companies that he says are inherently risky, especially among mid- and smaller-cap names.

SK Hynix, Seagate and Western Digital are examples of companies that fit that bill, and they were added to the portfolio via their convertibles. “There are different cycles regarding IT spending, and also different cycles within memory and storage,” Hillenbrand explains. “With higher-risk and higher-volatility names, [convertible] structures allow us to take on that risk when we think it’s appropriate, enabling us to grab some of the upside while mitigating some of the downside.”

The other risk bucket involves traditional higher-growth companies with higher-risk profiles. One example he cited is portfolio holding Axon Enterprise, a maker of law enforcement weapons, cameras and software that was formerly known as Taser International.

Investment Process
Along with Hillenbrand, the fund’s four-member portfolio management team includes Eli Pars, Jon Vacko and Joe Wysocki. Hillenbrand is the fund’s lead portfolio manager and primary decision-maker.

The portfolio managers and other research team members combine top-down analysis with bottom-up fundamental research. The top-down approach looks at macroeconomic factors such as inflation, interest rates, fiscal and monetary policies, consumer spending, and how businesses are performing.

The team also seeks to identify themes that can drive growth for specific industries and companies. These can range from multi-decade secular growth trends to shorter-term cyclical tailwinds. “That gives us a broad view about how much equity sensitivity we want, how aggressive or defensive we want to be,” Hillenbrand says.

From there they take a bottom-up approach to zero in on companies with improving fundamentals and attractive valuations. They look at balance sheets, management teams and competitive positioning to assess the value of businesses. “High margins and improved capital efficiencies are catalysts in almost any market,” Hillenbrand says.

After finding the right companies, Hillenbrand says the team next looks at their capital structures to figure out whether to hold their equity, fixed income or convertibles (if they have convertibles). “And we can apply an options strategy to that,” he adds. “Again, we’re trying to put some type of asymmetric risk profile into this from either a valuation or a structural standpoint.”

Calamos posits that the fund’s use of convertibles and options gives it more ways to navigate market, economic and interest rate cycles than traditional asset allocation funds using only stocks, bonds and cash.

Portfolio Fit
Hillenbrand notes that investors typically use his fund in a couple of different ways. One is having it be part of the core of their portfolio to give it lower-risk equity exposure. Another way is for investors to use the fund tactically when they want to take some risk off of their portfolio but still have some equity exposure.

Calamos views the Growth and Income Fund as part of a core allocation to be held over full and multiple market cycles. Doing so, the company believes, enables investors to withstand the equity market’s inherent volatility and avoid the temptation of market timing.

One could argue that the fund’s consistent long-term results lend credibility to the company’s assertion.