ICVT: A Tactical View On Convertible Bonds

Summary

  • ICVT facts and portfolio.
  • Historical behavior.
  • A tactical ETF rotation.
  • This idea was discussed in more depth with members of my private investing community, Quantitative Risk & Value. Learn More »

ICVT facts

The iShares Convertible Bond ETF (BATS:ICVT) tracks the Bloomberg Barclays U.S. Convertible Cash Pay Bond > $250MM Index. The expense ratio is 0.20% and the 12-month trailing yield is about 1%.

As described in the prospectus, “The universe of securities that are eligible for inclusion in the Underlying Index includes U.S. dollar-denominated securities with maturities of 31 days or more and $250 million or more of outstanding face value.” The index is market capitalization-weighted and rebalanced once a month.

The index has 310 components, exclusively cash pay convertible bonds. It is a class of convertible bonds giving the option to convert into a pre-specified number of shares of the issuer’s common stock, but do not require conversion. Other classes of convertibles (zero coupon, preferred and mandatory convertible bonds) are not eligible. The weighted-average maturity is 3.94 years and the average coupon rate is 1.26%. More than half of the portfolio has a maturity in the 3-5 years range. There is no condition on the issuer's credit rating.

Due to embedded optionality, ICVT is considered by some brokers (at least by Interactive Brokers) as a derivative product in the same category as leveraged, inverse and volatility ETFs. This may require some adjustments in your trading permissions parameters if you want to buy it.

ICVT portfolio

In summary, ICVT is a portfolio of 310 corporate bonds with an average rate of 1.26% and an average duration about 4 years, attached to specific call options that are not separately traded.

Optionality allows growth companies to borrow money at a lower rate, and possibly avoid paying the principal, should the bond be converted (in this case, the debt is “paid” by common shareholders in dilution). Optionality is also attractive for lenders willing to mix fixed income and speculation on share price. As a consequence, ICVT portfolio is growth-oriented and as hybrid asset, its behavior is part equity, part fixed income. ICVT's heaviest sectors are technology, consumer cyclical and communication. The next table lists the top 20 issuers, for about 34% of the portfolio. Each issuer may correspond to several bonds held in ICVT.

Company

Sector

Weight %

TESLA INC. (TSLA)

Consumer Cyclical

3.45

SEA LTD. (SE)

Technology

2.66

DISH NETWORK CORP. (DISH)

Communications

2.17

ZILLOW GROUP INC. (Z)

Consumer Cyclical

2.17

SQUARE INC. (SQ)

Technology

2.1

SNAP INC. (SNAP)

Technology

2.06

WAYFAIR INC. (W)

Consumer Cyclical

1.9

PINDUODUO INC. (PDD)

Communications

1.76

PALO ALTO NETWORKS INC. (PANW)

Technology

1.75

LIBERTY MEDIA CORP. (LSXMA)

Communications

1.66

BILIBILI INC. (BILI)

Consumer Cyclical

1.49

SOUTHWEST AIRLINES CO. (LUV)

Transportation

1.41

MATCH GROUP (MTCH)

Communications

1.37

IQIYI INC. (IQ)

Communications

1.28

SPLUNK INC. (SPLK)

Technology

1.14

COUPA SOFTWARE INC. (COUP)

Technology

1.13

DEXCOM INC. (DXCM)

Consumer Non-Cyclical

1.11

EXACT SCIENCES CORP. (EXAS)

Technology

1.1

NORWEGIAN CRUISE LINE (NCLH)

Consumer Cyclical

1.05

OKTA INC. (OKTA)

Technology

1.02

Historical behavior

Readers familiar with the matter know that 2020 was a very special year for convertible bonds funds (ICVT, but also CWB and some closed-end funds like CHI and CHY). First, let’s have a look at ICVT behavior from inception to December 2019, which is more representative of normality. The next table compares it to SPY: maybe not the best benchmark for convertibles, but it shows similar risk metrics on this period (drawdown and volatility)

06/02/2015 - 12/31/2019

Annual Return

Drawdown

Sharpe ratio

Volatility

ICVT

8.65%

-18.52%

0.71

10.95%

SPY

11.89%

-19.35%

0.91

12.20%

For the recent period, the next table shows data since January 2020. ICVT soared due to a speculative rally in common stocks of issuing companies. Tesla (TSLA) is the best example and the heaviest company in the portfolio, but a number of other names also boosted ICVT price.

12/31/2019 - 03/10/2021

Annual Return

Drawdown

Sharpe ratio

Volatility

ICVT

57.40%

-32.18%

2.05

26.21%

SPY

19.18%

-33.72%

0.77

23.85%

ICVT tactical rotation

Tactical allocation strategies consist of over-weighting assets with the highest probability of future gains. This probability is often arbitrarily measured by past performance. Countless variants are possible depending on the performance metric, weight calculation, look-back period, decision frequency, asset list, number of positions. The next table tracks a strategy with only two ETFs: ICVT and the iShares 7-10 Year Treasury Bond ETF (IEF). Every week, it goes long 100% in the ETF with the highest 3-month return, or in cash if both have their prices below the 200-day simple moving average. This ICVT-IEF rotational model is compared to two bond benchmarks: a total bond market ETF (BND) and IEF itself.

06/02/2015 - 03/10/2021

Annual Return

Drawdown

ICVT-IEF rotation

6.76%

-5.36%

Bond Benchmark (BND)

3.31%

-10.67%

IEF

3.27%

-8.82%

Calculations with Portfolio123. Past performance, real or simulated, is not a guarantee of future returns.

Conclusion

ICVT had an exceptional performance in 2020 due to its concentration in high momentum companies. This trend is not representative of its long-term behavior. Price action from 2015 to 2019 shows a less attractive picture, with risk metrics similar to SPY and a lower return. However, ICVT correlation to stocks may boost the performance of a bond ETF portfolio in a bull market. In any market conditions, ICVT may be combined with other bond ETFs in a tactical allocation strategy. The ICVT-IEF rotation presented here is a simplistic example. QRV Bond Rotation is based on the same idea.

Quantitative Risk & Value (QRV) provides you with data-driven strategies and updates of my portfolio. QRV covers most areas of interest for individual investors: market risk evaluation, growth with stocks, income with closed-end funds, safety with bond rotation. Get started with a two-week free trial and improve your investing decisions from day one. 

This article was written by

Fred Piard profile picture
14.46K Followers
Data-driven portfolios and risk indicators.
Author of Quantitative Risk & Value and three books, I have been investing in systematic strategies since 2010. I have a PhD in computer science, an MSc in software engineering, an MSc in civil engineering and 30 years of professional experience in various sectors. My aim is making simple and efficient quantitative investing techniques available to my followers. Quantitative models can make investment decisions faster, reproducible and emotionless by focusing on relevant information in the middle of market noise. Moreover, models can be refined to meet specific risk tolerance and objectives. 

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I am an individual investor and an IT professional, not a finance professional. My writings are data analysis and opinions, not investment advice. They may contain inaccurate information, despite all the effort I put in them. Readers are responsible for all consequences of using information included in my work, and are encouraged to do their own research from various sources.

Disclosure: I am/we are long ICVT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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