A UNIQUE FUND FOR BOTH RAIN AND SHINE

Not many investors are familiar with convertible bond funds, but Aviva has introduced such a fund here not too long ago. The Aviva Global Convertible Bond Fund is jointly managed by fund managers David Clott, who is based in the US, and UK-based Tom Wills. The mother fund is domiciled in Luxembourg and has a fund size of around $463 million as at 5 November 2002.

Convertible bonds, commonly known as CBs, are catching on because of their unique ability to participate in stock price increases, yet limiting the downside by acting as a bond. The safety net is known as the "bond floor", which limits the loss investors may sustain. When equity markets fall, the bond characteristics will help to create this floor and shelter investors from further damage. But do note that a significant number of global CBs are not rated or are in the sub-investment grade.

How do convertibles work? Let us assume that the par value of a CB is $1,000. If it has a coupon rate of 6%, it will pay investors $60 annually. Investors who choose not to convert will receive yearly income, and get back their capital when the bond matures - assuming there is no default.

As a CB has the option to convert to a specified number of shares by a certain date, most companies who issue CBs usually offer a lower coupon rate, or in some cases zero-coupon. Buyers of CBs can exercise their right to convert when the share price of a company goes above the conversion price, in financial jargon known as "in-the-money". When the conversion price is determined by the issuer, dividing the par value of the CB by the conversion price will give you the number of shares you are entitled to (conversion ratio). So if the conversion price is $2.00, number of shares to be exchanged works out to 500 ($1000 divided by $2.00).

When the stock price is close to the conversion price, the CB will usually act like a stock, and participate in equity movements. According to David and Tom, one of the fund's CB, Charles River Labs, a healthcare services provider, achieved nearly 80% of the upside participation when the stock rallied by 30% or so. The CB has a yield of 3.5% and is due 2022, and to date, the CB is up 23.5% with income. The upside participation of a CB is derived as a percentage of the stock price increase. So, with returns of 23.5%, it is around 80% of the stock price increase of 30%.

The downside buffer is illustrated by another example in the fund. Sprint PCS saw its share price crash by 84% during the time when the fund held its CB. But the CB 4% due 2029, is down by less than 9% with income. That is a participation rate of around 10% of the downside, which is much less severe compared to investors who had bought the company's shares and saw their equity value tank by more than 80%.

The fund managers of the Aviva Global Convertible Bond Fund adopts a bond selection process that incorporates top-down as well as bottom-up approaches. Once the macro picture, assisted by Aviva's house view, is determined, geographical regions are over-weighted or under-weighted. Next, bonds are picked after analysis of their credit quality, price, yield, and the upside or downside profile it offers.

CBs are attractive to many investors at this moment because of the low downside risk it offers, say the fund managers. The fund's strategy is to maintain a balanced profile that can achieve good upside for equity participation, yet provide a bond floor. When markets rise, CBs that have become too "equity-like" will be sold, they add.

The fund's top 10 holdings as at 5 November are Echostar 5.75% CNV (2.2%), Ford Cap 6.5% CNV PF (2.1%), General Motors 5.25% PFD (2.4%), Pernod Ricd 2.5% CNV (2.4%), Korea Telecom 0.25% CNV (2.4%), Telefon Mex 4.25% CV (2.2%), Evi Inc 5% CNV PREF (2.3%), Sega 0% CNV 06/2004 (2%), Parmalat CNV 6.125% (2%), Lufthansa 1.25% CNV (1.9%). There are approximately 84 holdings in the fund currently.

In terms of geographical allocation, United States has the biggest exposure, at 47%. Europe accounts for 34%, while the rest of the funds are spread across Asia and other countries.

The fund managers believe that consumer and healthcare offer better value currently, so 25.9% and 15% of the portfolio is invested into these sectors respectively. The rest of the portfolio is invested in technology (10.4%), industrials (10.2%), basic industries (8.5%), energy (8.2%), utilities (8.2%), financials (8.1%), and communication services (5.3%).

Although the fund offered here is a feeder fund, management fees are charged once, at the level of the Singapore-registered fund. Total expense ratios, according to Aviva, is one of the lowest in Singapore. Usually, fund size plays an important part in determining expense ratios. If the fund is too small, the fund manager may have to end up digging deeper into their pockets to pay for the fund's expenses.