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May 27, 2020
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There is an old saying in the investment business: “You can always tell the market-timers: they’re the ones with the holes in their shoes.” While there may be cycles in the stock market, The Turnaround Letter doesn’t know anyone who can successfully time those cycles, so our stock market advice for turnaround investors is not to attempt market timing.

Convertible bonds are an attractive vehicle for investors who want equity-like returns but cannot bear the volatility of stocks. A convertible may also provide more current income than the underlying stock. A convertible bond is a bond that can be exchanged for stock at a certain price ratio. As a bond or a debt obligation of the company, the convertible pays you interest periodically and then pays you back your principal at maturity even if the stock declines in price. It also gets paid off ahead of the stock if the company files for bankruptcy. These bond-like characteristics usually keep the convertible from falling too far if the company has poor results.

With investors’ faith in the long-running economic expansion and bull market being tested, we thought some comments on high yield bonds would be of interest to turnaround investors. Companies with these bonds, sometimes referred to as “junk bonds,” often are, or probably should be, in turnaround mode. And, if the companies eventually file for Chapter 11 bankruptcy, they can provide appealing distressed bond or post-bankruptcy stock opportunities. Given their riskier nature, high yield bonds tend to behave more like stocks than other, higher quality bonds.  

When is it possible to buy stocks at large discounts to what everyone else pays? When you buy them through a closed end mutual fund. Like open-end mutual funds, closed end funds (“CEFs”) hold actively managed baskets of publicly-traded stocks. Yet unlike their cousins that can expand or shrink their size based on whether investors are buying or selling, closed end funds have a fixed number of shares. Investors can trade the shares throughout the day at whatever price the market determines.

It is easy to get mesmerized by the potential gains in a turnaround stock and put in too much of your money. Even if you avoid most of the common turnaround investing mistakes, events may not work out the way you expected. The best way to manage this risk is through diversification.   While important to any investment program, diversification is critical to successful turnaround investing, as turnaround investing carries higher risk than traditional stock investing. Some turnaround stocks will produce large returns, others small returns, and some may even produce large losses. If you diversify, however, an unlucky pick or two may be more than offset by one or two big gains from other turnarounds that you own.

It’s mid-May and proxy season has arrived. Holders of individual stocks have been receiving documents with cryptic instructions from their companies, and in some cases blue and white “Dear Fellow Shareholder” pamphlets urging them to vote for or against some proposals.   Many investors are familiar with proxies and can quickly complete the voting process. But, for other investors, this may all be new. So, what are proxies, and why do they matter?  

Investing in distressed securities can produce outsized gains, but also involves more risk than investing in traditional securities. In our final note in the series, The Turnaround Letter steps away from the mechanics and analytics to share some thoughts on how to handle the emotions involved, when to exit and the role of  distressed securities in your portfolio. We’ll wrap it up with a quick review of the series.