Fund Spotlight

When interest rates are low and rising, floating-rate mutual funds are vehicles that may provide fixed-income investors with a way to achieve potentially significant higher returns, albeit by taking on more credit risk. The debt securities in these funds periodically adjust based on the prevailing interest rates, most often tied to a well-known benchmark such as the London Interbank Offered Rate (LIBOR). These funds typically have yields between those generated by investment-grade and high-yield bond funds.

Floating-rate loans are generally of lower credit quality versus investment-grade bonds, but interest paid generally adjusts every 30 to 90 days. The rate is based on an accepted standard, such as LIBOR, and a spread based on the creditworthiness of the borrower, the value of the collateral and associated loan covenants. Also known as senior bank loans, prime rate funds or syndicated debt, the loans are secured by inventory, hard assets or accounts receivables. These loans are generally senior to bonds, preferred stock and common equity within a company’s capital structure. This seniority compensates investors for the lower credit quality of the loans. After banks originate the loans, they are sold as collateralized loan obligations to hedge funds and mutual funds.

Aside from the potential for rising income, floating-rate bonds also have lower interest rate risk. Duration is used to measure this rate risk and a simple rule of thumb is that for every year of duration, a fund will fall 1 percent for every 1 percent increase in market interest rates. Most floating-rate funds have a duration below 1 year, indicating very low risk from rising interest rates.

Fund Overview

Investors seeking to increase the yield on the income-generating portions of their portfolios should consider the 5-star Morningstar rated RidgeWorth Seix Floating Rate High Income Fund (SAMBX). Managed by an experienced team led by George Goudelias, the fund seeks a high level of current income. Portfolio managers normally invest at least 80 percent of AUM in short-duration, fixed-income securities. In addition to certain hedging strategies, the fund may invest in loans to non-U.S. borrowers, including non-dollar-denominated credit. Supported by three co-portfolio managers, Goudelias has led the team since the fund’s inception in 2006. SAMBX still holds an overall five-star Morningstar rating.

Portfolio managers search for securities they believe are improperly graded by various ratings agencies. The team looks for securities with improving credit metrics, favors securities with strong underlying asset value, and prefers ratings of BB and B. The team will add securities with a lower credit rating if they meet the fund’s overall investment criteria. Managers avoid service industry-related firms with minimal assets and concentrate holdings in asset-rich organizations such as hospitals, broadcasting companies and energy firms. The team also prefers companies with improving cash flows, access to liquidity, strong management and attractive competitive advantages.

The fund generally eschews second-lien financing and other loans positioned lower in a company’s capital structure. Managers avoid loans with small deal sizes, shunning those valued at less than $300 million. The fund has less than a 3 percent stake in these smaller deals, which compares with the 11 percent allocation of the benchmark Credit Suisse Leveraged Loan Index.

Composition and Holdings

With 356 individual holdings, the portfolio features a 6.2 percent yield-to-maturity. SAMBX has an average maturity of 4.5 years and an average duration of 0.3 years. The 30-day SEC yield is 5.00 percent. Slightly more than 86 percent of AUM are allocated toward bank loans. The fund also has a 5.4 percent exposure to corporate bonds, a 5.7 allocation to government bonds and a 2.2 percent cash position. The credit distribution is heavily weighted toward B- and BB-rated loans. The top five holdings account for 12.28 percent of assets. The positions include SSC Government GVMXX, Fortescue Metals, Level 3 Financing, Hilton Worldwide Finance and Clear Channel Communications. SAMBX has a 33 percent turnover ratio.

Historical Performance

The portfolio’s slight overweighting toward the energy and commodity sectors detracted from last year’s performance as energy and commodity prices sold off. This was somewhat offset by the shift toward higher-quality BB-rated loans and a smaller exposure to lower-quality B-rated paper. Although the fund experienced a decline during the last financial crisis, it outperformed 85 percent of its peers. As of the end of August 2016, SAMBX has generated 1-, 3- and 5-year returns of 4.11, 3.14 and 4.97 percent, respectively. These compare with the benchmark returns over the same periods of 3.74, 3.41 and 5.32 percent, for the same periods

Risks, Fees and Distributions

The fund has a 3-year beta of 1.18 and a standard deviation of 3.47. Although SAMBX has an above average Morningstar risk rating, it features a low 0.62 percent expense ratio. It also has an above-average Morningstar return rating.

Suitability

The current low-interest-rate environment may encourage investors to search for financial instruments that deliver additional yield. In the case of bonds, investors can choose to add credit or interest rate risk, but as soon as rates rise, interest rate risk will bite into returns. Floating-rate funds provide a good compromise. SAMBX should perform similarly to high-yield bonds but with less risk. There is the opportunity to earn additional income from the price appreciation during a period of economic growth and anticipated higher interest rates. If the rise in interest rates this year continues into 2017, investors can look forward to rising dividends as the loans in the fund adjust higher.

The U.S. Department of Labor (DOL) has finalized a broad set of new regulations that will greatly impact the retirement investment industry. The Fiduciary Rule (also referred to as the “Conflict of Interest Rule”) is the first significant change since the Employee Retirement Income Security Act (ERISA) of 1974 and has been developed in response to the evolving retirement landscape and the exponential expansion of options available to retirees. Over the past 40 years, participant-controlled 401(k) plans, individual retirement assets (IRAs) and annuities have emerged, often displacing traditional employer-sponsored, defined-benefit plans.

While the variety of investment options has greatly benefited many retirees and families in recent years, the increased complexity has also left some investors vulnerable to plans that do not suit their individual needs. The Fiduciary Rule seeks to protect retirement assets by limiting an
investment professional’s ability to steer client assets into products that reward the advisors more than the clients. The U.S. government estimates suggest an annual loss of $17 billion to investors due to such suboptimal investment advice.

Morningstar estimated that over $3 trillion of advised IRA assets under management and the associated $19 billion of revenue would be affected by the Fiduciary Rule, with more than $1 trillion likely to move into passive investments. With so much money at stake, many in the financial advice industry continue to fight against the rule’s implementation, leading to lawsuits such as the one by the National Association for Fixed Annuities against the DOL, which claims that the rule overregulates IRAs, misclassifies insurance agents as fiduciaries and hurts the average American retiree.

Fiduciary versus Suitability Standard of Customer Care

Generally, two types of entities provide investment advice to plans: investment advisors and broker-dealers. Many retail customers may not realize that the two are held to different standards of customer care. Investment advisors typically provide investment recommendations and/or manage client assets and are registered either with a state or with the SEC, as part of the Investment Advisors Act of 1940. Registered investment advisors are held to a fiduciary standard of client care – they not only must have their clients’ best interests in mind, but also must put their clients’ interests before their own in all situations. As fiduciaries, registered investment advisors are held to the duties of loyalty to and care for their customers. For example, the advisors cannot front-run – trading recommended securities ahead of their clients – or hide potential conflicts of interest.

Investment brokers, working under broker-dealers and selling investment products to their customers, serve as intermediaries between the investors and the products, earning a commission based on the amount sold. Broker-dealers are regulated by a different body – the Financial Industry Regulatory Authority (FINRA) – under the Securities Exchange Act of 1934. Broker-dealers are held to the suitability standard of client care, which means that they make recommendations based on what they perceive as suitable according to the client’s objectives, risk preferences and time horizon at the time of the transaction, but – and here is the difference – they do not need to place the client’s interests ahead of theirs. These brokers are accountable to their broker-dealer firms and not to their clients. Investment banks typically create many products and ask the brokers to sell these investments. In addition, insurers offer structured products such as fixed indexed annuities, and these products are not regulated by the SEC but by state insurance departments, which are not as strict as the SEC.

Conflicts of Interest

One common potential conflict of interest under the suitability standard has to do with fees. Under the fiduciary standard, advisors cannot legally recommend investment products just because they give them higher fees or commissions. Under the suitability standard, investment brokers can sell to customers based on how much they would earn in commissions, thus prompting brokers to sell higher-load or higher-commission products. A 1 percent reduction in returns due to these higher charges can reduce retirees’ nest eggs by 25 percent over 35 years.

Asset managers often pay brokerages an amount for distributing their mutual funds, a practice termed “revenue sharing.” In a 2015 disclosure document, brokerage firm Merrill Lynch disclosed that it received compensation depending on a fund’s upfront sales charges, dealer concessions, asset-based sales charges and/or other service charges. Merrill Lynch rewarded compensation and other promotional programs, based on its volume of mutual fund sales. Some brokers may not fully disclose these payments to their customers.

Fixed indexed annuities, which have been rising in popularity, are actually insurance products and not securities. They have a minimum guaranteed yield plus an extra yield that is tied to the performance of the underlying indices – stocks, bonds or commodities. They are principal-protected but are subject to return caps and a long lockup. How these complex structured products earn their revenues is often opaque to customers. Insurance agents or brokers may receive commissions ranging from 1.5 to 12 percent for selling fixed index annuities, often downplaying their complexity and withdrawal fees in order to coax retirees into buying these products, the returns of which can be manipulated by the insurers.

Impact on Brokers and Advisors

The DOL’s conflict-of-interest final rule, which will become effective in April 2017, requires those who provide investment advice to plans to adhere to the fiduciary rule. Advisors and brokers can still receive their preset compensation. However, they must meet the “Best Interest Contract Exemptions,” whereby the institutions and their professionals sign in writing that they adhere to a fiduciary standard to their clients, act in their best interests, charge reasonable compensation that must be disclosed, and reveal any basic conflicts of interest. This opens the door for unhappy clients to file class action lawsuits against their advisors. At the same time, most believe that the new DOL rule may actually force annuity manufacturers to create better annuities and offer a higher level of due diligence to their investors. This may lead to better and simpler products and lower surrender charges.

Impact on Registered Investment Advisors (RIAs)

RIAs are already held to a fiduciary standard by the SEC and should not be significantly affected by the new DOL rule; however, the fiduciary standard set out by the DOL is more stringent than that of the SEC. Under the DOL standard, not only are commissions an unacceptable form of compensation but advisors also cannot incur any potential conflicts of interest when providing retirement advice. For example, rolling over a client’s 401(k) assets into an IRA constitutes investment advice and triggers the fiduciary standard of care. If the rollover results in higher net fees to the advisor or higher assets under management, such transactions are prohibited under the DOL rule. The exception for continuing with these activities requires that advisors disclose the rationale and dollar costs behind their recommendations.

Conclusion

While the new DOL rule requires brokers and advisors to operate in the best interests of their clients, investors nevertheless should be diligent in selecting advisors and understanding the products they recommend. Remember, too, that the new fiduciary standard for brokers and advisors applies only to retirement advice and not to advice on taxable investment accounts. That would lead to investors having two standards of care when they have two different types of accounts within the same brokerage firm. Over the coming months, many industry participants are likely to announce further changes in their business and compensation structures in order to survive under the new rule.

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The current low interest rate environment has been difficult for income-oriented investors. Traditional fixed-income investments, such as certificates of deposit, money market funds and longer dated bonds, are not producing appreciable yield, especially in taxable accounts. Dividend-paying stocks tend to be less volatile than the overall market. In addition to regular dividend payments, these stocks also have the potential for capital appreciation. Dividends instill discipline on company management while encouraging the prudent use of capital resources.

WisdomTree High Dividend (DHS) ETF offers a practical alternative to traditional fixed-income investments. DHS also pays dividends monthly, making it a compelling option for retired investors in search of steady income payouts.

Investment Strategy

Designed to track a benchmark comprising the highest-yielding 30 percent of dividend-paying stocks, DHS follows a dividend-focused strategy. It minimizes risk by weighting selections based on the stock’s proportional income to the total amount of dividends paid. The companies that pay out the largest dividend amounts tend to be larger-cap firms that experience less volatility than the typical high-yield stocks. This fundamental “dividend of a dividend” approach offers a strong indicator of the underlying value of the payout. The strategy is designed to give investors a higher return relative to the same amount of risk. It also has a greater tilt toward companies that are considered undervalued, and have a greater potential to outperform, as compared with the portfolios of other large-value funds.

While the current value tilt of DHS is less than it has been in the recent past, the fund still seeks out higher-yielding but potentially riskier stocks. The benchmark index requires that companies have paid out a dividend only over the past 12 months. This standard enables the fund managers to cast a wider net to include large companies that have only recently begun to return profits to shareholders. DHS invests in some of the market’s largest and most liquid dividend-paying companies.

Portfolio Construction

Because of its investment and rebalancing strategies, the fund naturally shifts toward the market’s highest-yielding stocks and sectors. As a result, DHS is currently underweight financials and overweight sectors that offer higher yields, such as energy, telecommunications and utilities. The fund’s concentration in these sectors is higher than the category average as well as that of comparable funds such as the five-star Morningstar-rated Vanguard High Dividend Yield Index Fund (VYM). DHS also has a large exposure to real estate, while VYM has a minimal exposure to that market sector. VYM has a higher exposure to industrial and technology shares compared with the higher consumer staples concentration contained within the DHS portfolio.

DHS has a 50.56 percent exposure to giant-cap shares as well as 27.87 and 14.56 percent allocations to large- and medium-cap companies, respectively. The fund has less than a 7 percent exposure to small- and micro-cap shares. Slightly less than 36 percent of assets are in the top 10 holdings. These include AT&T, ExxonMobil, Verizon, Chevron and General Electric as well as Procter & Gamble, Wal-Mart, Pfizer, Philip Morris and Merck. The fund has 37 percent of its assets in companies with a wide economic moat rating from Morningstar. This compares with the 53 percent of VYM. A wide economic moat indicates that the company has a sustainable economic advantage.

Despite the difference in the quality of the stocks in the DHS portfolio, they are not more attractively priced. The ETF has a forward P/E ratio of 18.1, which is higher than the 17.3 ratio for the Russell 1000 Value Index. Stocks in the fund also have a debt/capital ratio that is 28 percent higher than the ratio of the Standard & Poor’s (S&P) 500 index.

Performance and Risk

The fund has a high four-star Morningstar return rating. Over the past 1-, 3- and 5-year periods, DHS has generated total returns of 24.73, 13.45 and 15.28 percent, respectively. These compare with the category returns over the same time frames of 16.19, 11.30 and 14.76 percent, respectively. The fund has a 12-month yield of 3.19 percent compared with the 2.99 percent and 2.09 percent respective yields for VYM and the S&P 500. While DHS has a 3-year beta and standard deviation of 0.84 and 9.56, the comparable numbers for VYM are 0.96 and 10.15. The lower correlation and lower volatility are mainly due to the larger weights in the telecommunications and utilities sectors. The last distribution occurred on August 22 for 0.185 per share with a reinvestment price of $67.

Suitability

The fund is a good option for investors who seek a targeted exposure to high-yielding domestic equities. It can be used to replace or complement passive and active large-cap value and dividend-oriented investment strategies. The ETF also satisfies the demand for potential growth as well as current income. The fund has a lower correlation to the S&P 500 index, which indicates that it has greater diversification. Although the inclusion of DHS in a well-balanced portfolio may lower overall risk as it generates high yields, the ETF is a riskier stand-alone ETF than a typical large-cap blend fund.

The search for yield may cause the fund to tilt more toward distressed firms that may not be able to sustain their dividends, especially during a downturn. The fund suffered higher percentage losses than did the overall market during the recent financial crisis. Another drawback is the 0.38 percent expense ratio, which is higher than the category average and significantly higher than the 0.09 percent expense ratio of VYM. Because of its potential risks, DHS may be best suited as a satellite, rather than a core holding, for those looking for current income.

One of the most prominent trends recently in fund investments has been a focus on sustainable, responsible and impact investing (SRI) – an investment discipline that uses environmental, social and corporate governance (ESG) metrics to produce long-term portfolio returns and a positive impact on society. According to the Forum for Sustainable and Responsible Investment, SRI assets reached $6.57 billion in the U.S. in 2014, about 18 percent of the total assets under management. Evidence supporting the link between ESG criteria investing and corporate financial performance (CFP) is also growing. A 2015 study by Deutsche Asset & Wealth Management Investment and the University of Hamburg, Germany, has shown a positive correlation in 90 percent of the 2,200 individual studies analyzed. Mutual funds are particularly active in the ESG space, with the number growing to more than 450 and assets under management close to $2 trillion. Parnassus Investments is a long-established fund company that adopts the ESG investment principles in all of its six funds. Its flagship fund, the Parnassus Fund (PARNX), incepted on December 31, 1984, has done well by doing good, outperforming the S&P 500 Total Return Index and large-growth peers on a five-year, 10-year and 15-year basis according to Morningstar.

Overview
PARNX, the investor shares of the Parnassus Fund, invests across all capitalizations with almost 40 percent in medium, small and micro caps, holding around 40 stocks. Its stocks’ average market capitalization was $25 billion compared with the Russell 1000 Growth Index of $62 billion. About 88 percent was allocated to U.S. stocks, 5 percent to non-U.S. stocks and 6.8 percent to cash as of July 31, 2016. It has a four-star Bronze rating and the highest sustainability rating from Morningstar. Total assets reached $726.9 million on June 30, 2016. The minimum investment is $2,000, while the expense ratio is 0.84 percent, about 30 basis points lower than the Morningstar large-growth category average.

The fund invests across all the sectors but has traditionally been overweight in the technology sector compared with the benchmark and underweight in the utilities and energy sectors. This is not only because its headquarters are near Silicon Valley in San Francisco, but also because the fund’s technology companies lead many others in providing a good working environment.

Investment Strategy

Under lead manager Jerome Dodson’s stewardship, the fund has the stated objective of seeking capital appreciation, aiming to beat the S&P 500 Index with a high active share. The team first narrows down the investable universe using strict proprietary ESG criteria covering environment, governance, workplace, community and customers. As a result, the fund has had no stocks of companies related to alcohol, gaming, weapons, tobacco or nuclear power since 1984, and no fossil-fuel stocks since 2015.

The team also has a robust stock selection process, seeking companies that have strong competitive advantages for the long haul that allow them to make outsize profits (Warren Buffett’s “wide moats”); quality management teams that work for the shareholders’ best interests; and attractive valuation, usually contrarian.

The portfolio is concentrated with a stated position limit of 5 percent at cost. Each position is given a “core allocation” and “opportunistic capital” so that the fund dynamically adds to and subtracts from the stock position when the target price is reached or a better opportunity arises. The fund holds cash in the range of 1 to 10 percent.

Stock Selection
PARNX has outperformed its peers and the S&P 500 Index over the long term due to sector and individual security selections. The fund has traditionally focused on the technology sector with a significant overweight allocation of 34 percent in information technology compared with 20 percent in the S&P 500 Index, and a significant underweight allocation of zero percent in both energy and utilities compared with 7 percent and 4 percent, respectively, in the S&P Index as of June 30, 2016. It allocated only 3 percent to consumer discretionary compared with the index of 12 percent. The technology sector has become the largest sector in the S&P 500 Index and includes some of the world’s most valuable companies, such as Apple, Alphabet, Microsoft and Facebook.

With the cumulative outperformance of the S&P Growth Index by 33 percent and the S&P Information Technology Sector Index by 73 percent in the past 10 years over the S&P 500 Index, the PARNX fund has fared well against its peers and the benchmark. While this is a risk to the fund when the technology sector turns down relative to the index, the fund’s rigorous stock-picking discipline with strict ESG criteria may help mitigate this risk. One stock holding is Alphabet (GOOGL), which according to Dodson has a great moat, a good social story and model employee treatment, with generous maternity leave, fitness centers and time off for charitable events. While year-to-date the stock has trailed the S&P, it has a huge cash cushion, stable revenue, and an innovative and smart workforce, and it continues to be a long-term holding in PARNX.

Management Team
PARNX’s management team consists of Jerome Dodson, the founder of Parnassus Investments and portfolio manager of the fund since 1984; Ian Sexsmith, a portfolio manager since 2013; and Robert Klaber, a portfolio manager since 2016. The fund’s investment style is set by Dodson, who is a well-known technology analyst and has a career background that includes working in a nonprofit organization serving minority-owned businesses and at a bank that designed innovative products for depositors to invest in solar energy projects. While the other two portfolio managers have shorter tenure at the fund, they have both been senior research analysts with the firm since 2011 and 2012, respectively, with overlapping responsibilities across other funds’ teams. Given that Dodson is expected to retire as CEO in 2018 and to change some of his fund responsibilities, there appears to be enough lead time to mitigate the succession risk in this fund.

Performance
Based on Morningstar, year-to-date to August 26, 2016, PARNX has returned 6.07 percent per annum compared with the S&P 500 Total Return Index’s 7.67 percent and its large-growth peers’ 3.00 percent. The fund has underperformed the S&P 500 Index by 5.76 percent and 0.54 percent per annum on a one-year and three-year basis, but has outperformed its peers by 0.69 percent and 0.81 percent per annum in the respective periods. The fund has outperformed both the S&P 500 Index and its peers on a five-year, 10-year and 15-year basis, with a per annum return of 18.57 percent, 10.23 percent and 6.4 percent, respectively. The fund was rated Morningstar’s top-performing ESG fund in the 10-year period to June 30, 2016. The fund also ranks within the top 1 percent of the large-cap growth fund category during that period.

For the past five years to July 31, 2016, the fund has a 1.21 beta to the S&P 500 Index, with a higher standard deviation of 15.81 percent as compared with S&P’s 12.08 percent. While the fund has greater volatility, its 10-year upside capture ratio against the S&P 500 Index is 121 compared with 102 for its peers, according to Morningstar, which leads to the fund’s positive performance rating.

Conclusion
The Parnassus Fund (PARNX) combines ESG investment principles, portfolio concentration and value investing in Warren Buffett’s style, delivering outstanding long-term returns against the S&P 500 and its ESG and large-growth peers. It has one of the longest investment records – over 25 years – among ESG funds. The fund has navigated between the growth and blend styles with a traditional overweight in the technology sector given the manager’s expertise. Its sector concentration, higher volatility and potential succession issue are some of the risks to monitor. However, the firm’s investment philosophy of picking ethical and good social businesses with long-term competitive advantages that deliver good corporate performance at an undervalued price will help mitigate the risks mentioned above.

The current investment climate defies historically held common knowledge and perceptions concerning markets. In the past, bonds and stocks were inversely related; bond markets strengthened and yields declined as stocks declined, and vice versa. Due to recent central bank trends and policies, however, debt and equity markets are achieving new highs in tandem. The German-led European Central Bank and the Bank of Japan are both operating with negative interest rates in an effort to create market liquidity. Furthermore, economic stimulus to combat stagnant inflation has led to historically low bond yields at all-time high prices. The U.S. Federal Reserve has simultaneously kept markets on edge for rate hikes, with ambivalent language and indefinite postponements. Thus, investors are faced with the challenge of capitalizing on the bullish stock market without sacrificing potential yield amid rising bond prices. One solution may lie in convertible bonds.

Convertible Bonds

Constructed as a hybrid security, convertible bonds have a niche appeal for a number of yield-conscious institutional investors seeking the potential upside of specific stocks without the downside risks. Mechanically, convertible bonds are interest-bearing bonds that convert to common stock at a specific exercise price. Once the “strike price” is achieved in the equity market, the bonds appreciate in tandem with the common stock price. Convertible bonds offer investors the conservative, defensive nature of a bond, with the potential to turn into common stock in a market rally.

Savvy investors use convertible bonds to target a particular stock while hedging in order to achieve an interim return on investment while waiting for the stock to appreciate to a predetermined level. The bond coupon, while comparatively smaller than a traditional corporate bond issue, still maintains a yield factor that provides an annual income stream. The conversion option affords the investor the potential for larger gains if the stock price rallies.

Many institutional traders use convertible bonds for arbitrage by buying the convertible bond and shorting the stock. This allows for a “risk-free” profit, as they are technically long the stock through the bond. If the shares rally, they break even on the stock trade (the losses from the short are offset by the gains from the convertible bond), and if the shares fall, they make money on the short. In either scenario, interest payments are collected. Institutional traders provide a large market demand for these bonds, which benefits individual investors with a broader securities market that is ideal for indexing.

From the individual investor’s perspective, convertible bonds offer income and the additional opportunity for capital gains. Caution should be exercised, however, as debt from issuing companies is often on the lower tier of investment-grade or even lower junk status (companies normally pay higher coupon rates for senior debt issues when compared with companies rated BBB+ or better). Additionally, calculating valuations and following any prospective rating changes within a portfolio can be complicated. Premiums and cash-flow payback differentials are challenging to calculate on a per-bond basis, especially when the exercise price is close to the market price. Many issues also provide call provisions that often will be exercised in low interest rate environments, such as the current market. The prospective retail investor lacks the resources of a Bloomberg terminal and other industry tools that are in the hands of most industry professionals. The SPDR Barclays Convertible Securities ETF (CWB) offers a relatively simple way for individuals to participate in the convertible bond arena with diversification and relatively low transactional fees.

Composition

Founded by State Street Global Advisors in 2009, CWB tracks the Barclays US Convertible Bond > $500 MM Index, and is the largest and most established convertible-bond ETF on the market. The fund attempts to mirror the Barclays index, and this is reflected in most of the portfolio allocations, which are within 2 to 3 percent of the benchmark weightings. CWB has assets of $2.4 billion, and there are 53 million shares outstanding.

Within the fund, the average coupon is 3.77 percent, average maturity is 10.5 years, average price per bond is $125.6 and average yield-to-worst is 4.11 percent. Current yield is 3.61 percent, and average yield to maturity is 1.41 percent. Turnover average is 38 percent.

Due to the nature of the convertibles market and its associated companies, the bulk of CWB’s portfolio is lower-rated (BBB and under, or junk status), with a large percentage of unrated securities. As of August 15, 2016, the portfolio quality consisted of ratings as follows: Aaa (0.68 percent), A (6.43 percent), Baa (16.56 percent), below Baa (32.73 percent) and unrated (43.60 percent).

The maturity breakdown within the portfolio is as follows: 0-1 year: 9.34 percent;1-2 years: 16.82 percent; 2-3 years: 24.48 percent; 3-5 years: 14.81 percent; 5-7 years: 3.47 percent; 7-10 years: 3.84 percent; 10-15 years: 2.61 percent; 15-20 years: 3.46 percent; 20-30 years: 11.21 percent; and over 30 years: 0.89 percent.

From a sector perspective, CWB divides its portfolio with a predictably heavy weighting in technology, one of the biggest gain sectors in the equity markets. Of its holdings, 47.93 percent are technology companies, followed by consumer non-cyclicals (17.81 percent), finance (11.65 percent), energy (7.14 percent), communications (4.67 percent), consumer cyclicals (4.48 percent), utilities (3.92 percent), basic industry (1.41 percent), capital goods (0.66 percent) and other industrials (0.34 percent).

CWB’s current top 10 holdings are Mandatory Exchangeable Trust (5.75 percent), Wells Fargo (7.50 percent), Watson Pharmaceuticals (5.50 percent), Nvidia Corp. (1 percent), Bank of America (7.25 percent), Teva Pharmaceutical Industries (7 percent), Intel (3.75 percent), Verisign (4.34 percent), Tyson Foods (4.75 percent) and Intel (2.95 percent).

Fees and Expenses

CWB’s expense ratio is 0.40 percent. This is among the lowest available in the market. For comparison, the First Trust SSI Strategic Convertible Securities ETF (FCVT) is 0.95 percent, Franklin Templeton’s Convertible Securities Fund is 0.88 percent and the Fidelity Convertible Securities Fund is 0.85 percent.

CWB can be traded commission-free at Charles Schwab.

Performance

As of the end of the second quarter of 2016, CWB trailing total NAV returns for one year were 4.60 percent, three-year returns were 7.0 percent and five-year returns were 10.46 percent. A $10,000 investment made in 2009 at inception would be worth over $21,000 at present (including distributions).

The 30-day SEC Yield is 2.57 percent, and the 12-month yield is 5.23 percent. The difference generates from capital gains, which are paid almost every year. Investors should therefore consider holding the fund in a tax-deferred account.

Conclusion

CWB offers investors stock market exposure with a substantial yield, making it a solid choice for income investors who want equity risk. Since convertible bonds behave like equities once they hit a strike price, over the long run, funds such as CWB tend to behave more like stocks than like bonds. Investors should not expect defensive protection from CWB in the event of a market correction or a bear market. CWB is, however, approximately 30 percent less volatile than the broader S&P 500 Index. Finally, CWB is technology-heavy, and investors should evaluate current technology exposure before adding CWB to a portfolio.