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Convertible Securities Fund —
Convertibles post competitive returns despite Q3 decline
3rd Quarter, 2014
"Volatility generally is good for our strategy, enabling us to rebalance the portfolio, because we try to sell into strength and buy back later. "
– Shenkman Capital Management, Inc.

Convertible bonds declined in the third quarter of 2014 but continued to provide competitive returns with other asset classes on a year-to-date basis. The convertibles market returned -1.61% for the third quarter and 7.94% for the nine months ended September 30, 2014, as measured by the BofA Merrill Lynch All US Convertibles Index. By comparison, U.S. equities returned 1.13% for the third quarter and 8.34% for the nine-month period, as measured by the S&P 500 Index, while investment-grade bonds returned 0.17% for the latest quarter and 4.10% for the first nine months of 2014, as measured by the Barclays U.S. Aggregate Bond Index.
The Harbor Convertible Securities Fund returned -2.72% for the quarter, trailing the BofA Merrill Lynch All US Convertibles Index. The Fund invests primarily in convertible bonds, which can be converted into common stocks at a predetermined price. Portfolio Manager Ray Condon notes that the Fund seeks to achieve attractive risk-adjusted returns while at the same time protecting principal investments. As such, the portfolio typically is underweighted in high-delta securities, or bonds having a close correlation to the price of their underlying equity shares, as well as in convertibles trading well above their conversion prices. This hurt relative performance in the third quarter.
With respect to industry exposures, investments in Miscellaneous Industrials helped Fund performance relative to the index, as did minimal exposure to companies in the Oil Integrated and Foods industry categories. The portfolio's worst performing industries relative to the benchmark were Pharmaceuticals, Real Estate, and Internet Software.
Ray Condon's comments were made in an October 14, 2014, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended September 30, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through September 30, 2014.

Interview Highlights

Flight to quality
The convertible market reversed most of its August gains in September, resulting in the market's first negative quarter since the second quarter of 2012. The market backdrop for September was a flight to quality in both the fixed income and equity markets as exogenous global growth concerns resurfaced.
Index drivers
Continuing the momentum of the previous 18 months, index returns benefited from a handful of what we call high-delta, deep-in-the-money, very equity-like issuers, which we tend to underweight and avoid due to their lack of bond characteristics. Ten issuers alone, accounting for about 13% of the index, saw their underlying equities rise 19% in aggregate during the quarter, while underlying equities of the entire convertible index were down almost 4%. That translated into a contribution of 177 basis points, or 1.77 percentage points, to index performance, dramatically offsetting the rest of the index, the other 450 or so names, which were down approximately 3.38%.
Rebalancing opportunities
The sustained relative strength of the equity markets, seen in the first half of 2014 following a strong 2013, had a very different complexion as we completed the third quarter, spurred by the backdrop of weakness in commodities, the strength of the Dollar, and renewed concerns over global growth. As a result, opportunities to rebalance once again presented themselves. Volatility generally is good for our strategy, enabling us to rebalance the portfolio, because we try to sell into strength and buy back later. During the quarter we also found opportunities to realize gains as securities approached our price targets, while introducing new positions as appropriate.
Constructive outlook
From an outlook point of view, we continue to be constructive. We are seeing signs of episodic volatility after a two-year equity run, and we expect the convertible market to begin focusing to a greater degree on risk-adjusted returns. Another reason to be constructive, in our view, is the new-issue calendar. We had a strong new-issue calendar in 2013 and that has continued year-to-date. We've had 88 new issues totaling $35 billion. Assuming that the recent surge of new issues continues, we expect that, for the first year since 2007, convertible new issues will be net positive. As a result, the market is becoming, I would say, less mature with the reconstitution of the calendar, providing more potential investments for our entry point strategy.

Performance data shown represents past performance, which is no guarantee of future results. Current performance may be higher or lower than the past performance data shown. Investment returns and the value of an investment will fluctuate, and an investor's shares, when sold, may be worth more or less than their original cost. You can obtain performance data current to the most recent month-end (available within seven business days after the most recent month-end) by calling 800-422-1050 or visiting

Performance figures discussed reflect that of the institutional class shares.

The views expressed herein are those of the portfolio manager at the time of the interview and may not be reflective of their current opinions or future actions.  These views are not necessarily those of the fund company and should not be construed as such.

This information should not be considered as a recommendation to purchase or sell a particular security and the holdings or sectors mentioned may change at any time and may not represent current or future investments.