Tracy V. Maitland - Convertible Securities

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L uckily for me, my career as a money manager started off in convertibles. In 1978, when it was time for me to move on after roughly ten years in equity research at First National City Bank, my boss asked me what I wanted to do next. I responded that I was open to doing anything other than spend the rest of my life choosing between Merck and Lily. I firmly believe that some markets are quite efficient, meaning consensus views and thus security prices tend to instantaneously reflect the available information. This makes it hard for investors to regularly identify mispricings and profit from them. To me, the market for large-capitalization stocks was and is such a market, and few people are able to consistently add value there by choosing among those stocks.

In one of the many examples of the good luck from which Ive benefitted, my boss answered, Id like you to shift to the bond department and run a convertible securities fund. I did so, starting with the princely sum of $16 million (which seemed like a great deal of money at that time). I went from being director of research with a $5 million budget, 75 staff members and membership on the five most senior committees to working with no budget, no staff and no committee seats... and I was thrilled.

The convertibles market was an investing backwater: small and followed by few. Convertibles were and still are little known and little understood. Theyre hybrid securities with some of the characteristics of debt and some of equities, and for this reason they entail substantial complexity. Because of this hybrid nature, they dont fit easily into most institutional investors buckets asset allocation categories that have to be filled with securities meeting their definition; thus there are few natural buyers. And because issuing them requires companies to give up features of both debt and equity, they tended 40+ years ago to be issued as a last resort by companies in disrespected industries like conglomerates that had few alternatives.

Most people look at securities with these characteristics and see reasons not to get involved. But for me, the characteristics made convertibles highly attractive. How do investors make superior risk-adjusted big money? In general, by doing things others dont want to do. Companies and securities with obvious merit tend to be thoroughly understood, attractive to all, hotly pursued and thus fully priced. Thats not a great description for a place to look for bargains. Its often in areas that are affected by ignorance and prejudice that bargains can best be found, and for me that meant convertibles.

The investment world of 44 years ago was very different from that of today. There were no computerized data bases (and no personal computers through which to search them). There was no reporting of trading in convertibles. There was little performance data. Even the understanding of how to make money with less-than-commensurate risk was fragmentary and not widely possessed.

Warren Buffett talks about having been able to buy dollars for fifty cents. The convertibles market described above presented opportunities for me to do so (albeit not to his extent). There were securities no one knew about and few understood. Thus, there were opportunities to earn high returns without risk, and certainly without commensurate risk. The ability to make money without bearing risk is what we call a free lunch, and the efficient market hypothesis I studied in graduate school said such opportunities shouldnt exist. But in a little-known backwater like convertibles, they could and they did.