The Kansas City Royals, a proud franchise when I was growing up, were pretty awful for almost 30 years. The Houston Astros switched leagues a few years ago and got lots of dirt kicked in their collective faces. But now they are two young, winning post-season teams. Chasing yesterday’s winners works in baseball for a while, but not indefinitely. Teams that don’t retool effectively get old and tired.
So it goes with convertible portfolios. Sticking too long with winners usually means giving back gains. The nature of the asset class bespeaks countercyclicality and mean reversion. The age-old strategy of buying at 100 and selling at 150 works more often than it doesn’t. Of course, when everyone’s trying to do it, you will get plenty of cheap bonds at 150 and rich ones at 100. But rich and cheap aren’t everything. Risk and reward still trump (if the candidate will let us borrow his name) them.
Only up to a point, we add. Some bonds are untouchable regardless of price point. Yes, we mean Illumina. We regard last week’s body-slam in Illumina shares, thanks to a revenue shortfall, as poetic justice for the company’s uglier-than-sin convertibles. Still, the challenges in maintaining an appropriately hedged (is there such a thing?) short position in the bonds have never been trivial, and they were not last week either. The combination of higher volatility and a lower price point means both of the latest Illumina tranches are not quite as hideous as they used to be. But you can most assuredly do better.
More generally, we do think it’s time to look to laggards both long-term and recent. The top two names in our HOCS lists have suffered greatly in the recent health-care selloff. But even HOCS 20 is not infinitely patient—witness the exclusion of longtime leaders Tesla and Invensense from the “original recipe” list. The names still rate highly, but others look better.
We created our HARP and HOCS measures to help you strike a balance between rich/cheap investing and price-point investing. Nothing works all the time, and the more you keep things fresh, the better. Just ask the Yankees.
(This is the cover letter for the subscription-based weekly Hillside's Hybrid Vigor newsletter. For a complete copy, please contact John Anderson at + 1 (646) 712-9289 x 107).