Convertibles can help diversify your portfolio by improving the balance between risk and reward. This is because they respond to market events differently to both bonds (a loan, usually taken out by a government or company, which normally pays a fixed rate of interest over a given time period, at the end of which the loan is repaid) and equities (shares of ownership in a company).
For example, over the long term, convertibles typically produce similar returns to those of equities. But while the returns are similar, the risk is lower. Owning convertibles can therefore help to spread overall risk within an investment portfolio.
Convertibles are usually less volatile (when the value of a particular share, market or sector swings up and down fairly frequently and/or significantly, it is considered volatile) than equities. If share prices rise, you will benefit, and if share prices fall, you will still have some downside protection.
Most convertibles also benefit from yield (return on an investment over a given period, typically 12 months, relative to the current price of the asset) advantage. This means they pay you a fixed income stream that tends to be higher than the dividend yield to a shareholder of common stock.
Finally, convertibles enjoy a higher ranking than common shares within a company’s capital structure. In other words, you would have a claim on the assets of the underlying company and would receive a higher recovery value in the event of bankruptcy or liquidation.