PANW - CVRT: Calamos Launches Convertible ETF

2023-12-18 16:45:36 ET

Summary

• Calamos expanded into exchange-traded products earlier this year, more recently launching the Calamos Convertible Equity Alternative ETF.
• The firm specializes in convertible securities and has offered both open-ended and closed-ended funds.
• CVRT is ultimately focused more on potential appreciation rather than yield, with a focus on convertibles with an "equity-like" tilt.

Written by Nick Ackerman, co-produced by Stanford Chemist.

Calamos made a move into exchange-traded products earlier this year. A niche firm that generally employs a strategy with an emphasis on convertible securities, both traditional open-ended and closed-ended funds, in the mutual fund space. More recently, they made the debut of Calamos Convertible Equity Alternative ETF ( CVRT ). This ETF launched on October 4, 2023.

This investment firm goes back to the 1970s , and they manage about $36 billion. One of its oldest funds is the Calamos Convertible Fund A ( CCVIX ), having an inception date of June 21, 1985. While the fund's performance comparison against the iShares Convertible Bond ETF ( ICVT ) is cut short due to ICVT's short history, we can see that CCVIX had underperformed this passive benchmark.

It can be harder for a fund with a higher expense ratio to outperform passive indexes. The CCVIX fund charges a 1.10% gross expense ratio with a maximum front-end sales load of 2.25%. A sales load that is going to be present in the ETF wrapper. For what it is worth, they list on their website that the ICE BofA All U.S. Convertibles Index is their benchmark, in which they've seen underperformance as well.

CVRT carries a higher expense ratio as it is still actively managed, but it is lower than its mutual fund counterpart. That should bode well for the ETF to have a much better shot at outperforming the passive benchmark.

As I regularly cover the closed-end fund space and the Calamos funds that belong to that realm, including the Calamos Strategic Total Return Fund ( CSQ ), Calamos Convertible & High Income Fund ( CHY ) and Calamos Convertible Opportunities and Income Fund ( CHI ), I felt that doing an overview of their new ETF might be of interest. The fund isn't looking to employ leverage, but we still get the active management of this specialized firm.

The Strategy

CVRT's investment objective is quite simple; "to deliver total returns through capital appreciation and current income by investing largely in a portfolio of U.S. convertible securities exhibiting a high level of equity sensitivity."

More specifically, the prospectus for the fund states:

The Fund is an actively managed exchange-traded fund ("ETF") that invests in the segment of the U.S. convertibles marketplace that has a higher level of equity sensitivity. The Fund seeks to achieve its objective by investing at least 80% of its net assets (plus borrowings for investment purposes, if any) in a portfolio of convertible securities (including synthetic convertible instruments). The Fund's investment adviser is Calamos Advisors LLC ("Calamos Advisors" or the "Adviser").

The Adviser utilizes a quantitative and qualitative screening process that consists of a proprietary convertible model and fundamental inputs to identify securities that meet the criteria for inclusion in the portfolio and intends to rebalance the portfolio regularly to ensure that the desired exposures are maintained. The Adviser will also make active adjustments to the portfolio based on fundamental analyses (such as an issuer's financial soundness, ability to make interest and dividend payments, earnings and cash flow forecast and quality of management), as well as certain portfolio-level characteristics, such as the size of an issue (e.g., value of bonds outstanding), liquidity, trade execution, and exposure to macro-level investment themes.

In this case, CVRT is specifically targeting equity-sensitive positions instead of their CEFs, which tend to take a much more hybrid approach through investing in convertibles with sleeves of equity and/or high-yield bonds. Convertibles, in general, can be confusing for some newer investors, but they aren't overly complicated.

They have features of both fixed-income and equity qualities. They can participate in the upside due to their convertible feature into equity securities. However, they are also issued with a face value and generally pay some yield until the potential for conversion. If a price isn't reached, the face value will be paid to investors instead of converted to equity.

For CVRT's approach, Calamos provides a graph that can help illustrate their approach.

They believe that targeting convertibles with more equity-like features can provide "greater upside potential over time." That certainly is true; they definitely could , but that, of course, comes with greater risk rather than focusing on those with higher yields. With the fund's investment objective of "capital appreciation" before the "current income" wording, it makes sense what one is getting.

Therefore, it seems like this fund will generally be less focused on yield and more on the potential returns, making it possibly more appropriate to benchmark against an equity benchmark. That's exactly what we see in the material for this ETF as well, including not only the ICE BofA All U.S. Convertibles Index but also the ICE U.S. Core Equity Alternative Convertible Index.

They also specifically highlight that with this focus, they could "provide an improved risk/reward profile and added income advantage relative to owning small and mid-cap growth stocks." That is, they are highlighting the fund as being able to provide at least some income that the smaller companies in the world don't generally offer while also providing a lower-risk approach. Of course, with anything forward-looking, especially with a fund that is so new, it would yet to be determined if that ends up being the outcome.

Overall, the strategy could mean more volatility for investors in the fund for the chance at a better overall outcome.

Dividend Yield and Positioning

The growth over income strategy in the convertible space could seem fairly unique. However, that isn't really unlike the ICVT ETF, as it only sports a 1.82% twelve-month trailing dividend yield. I wouldn't necessarily call that stretching for yield. Excluding the expense ratio, ICVT would see a yield of about 2%.

Similar to ICVT, they are also targeting a monthly distribution policy, but I have not seen anything declared just yet.

The fund has listed all of its holdings at the end of November; however, being a new fund, they are likely going to take some time before getting 'settled in.' At this point, here are the eleven largest holdings. I went with eleven because Akamai Technologies, Inc. ( AKAM ) was the tenth and eleventh-largest holding, but it is also the eighth-largest holding.

Through holding three different issuances from this company, there is quite a bit of concentration, adding up to a 9.82% weight. That would make it the second-largest concentration in the fund if it were through one holding.

Additionally, Palo Alto Networks, Inc. ( PANW ) carries a significant weighting in CVRT's portfolio, with an allocation of 11.23% to its convertible issuance.

The PANW convertible securities come with a 0.375% yield. The AKAM convertibles yield 0.125%, 1.125% and 0.375% from the highest to lowest weight. That can provide us with some context of the types of yields CVRT might be targeting as they focus on equity-like features of their convertibles (i.e., lower yield but potentially higher appreciation.)

If this is any indication, CVRT could be sporting a yield even lower than ICVT's. In fact, after the expense ratio, we can see several of these aren't going to have a net yield left over for investors at all.

When zooming out from the individual top holdings on a broader level of the portfolio, the growth tilt is further reinforced by the fund being dominated by the tech sector allocation.

That said, one of the highlights from Calamos earlier this year was the fact that yields are rising. Newer offerings are having to sport a higher yield if they want to garner investor interest. Additionally, higher-quality companies have been employing convertible debt in an effort to reduce their refinancing costs as we move through this higher-rate environment. That should result in a benefit in that it should reduce overall risk while still achieving a higher yield. While yield certainly doesn't appear to be the focus of CVRT, it can be a natural side-effect of where we are in the current rate cycle.

The Expenses

Given the importance that an expense ratio plays on the overall total return of a fund, it's important to touch on this basic. The fund's expense ratio of 0.69% is likely to dissuade some investors.

After all, if we go back to ICVT, that fund runs with an expense ratio of 0.20%. With that being said, the average of all ETF expense ratios comes to around 0.50%. So, it is on the higher end, but that can be skewed by the amount of passively managed ETFs. It has been more of a recent trend where active managers have been providing more actively managed ETFs.

This isn't all that surprising when you consider there is an incentive for the firms to launch more expensive products, but it still requires the investors to pool into these instruments. So, while we've seen funds, particularly those that follow major indexes, come down to near or zero fees, that trend could reverse if investors keep pooling into active strategies.

Conclusion

CVRT is a new entrant to the convertible ETF space. Calamos runs several popular closed-end funds. For investors looking for active Calamos exposure but wanting to forgo leverage, this could be more appropriate. On the other hand, CVRT is unlike their CEFs in that they aren't focusing on income generation but targeting growth instead with an equity-like oriented approach.

CVRT is incredibly small at this point and carries an expense ratio on the higher end. If they are successful, they should see AUM grow while the expense ratio comes down over time.

CCVIX has 42 followers on Seeking Alpha, while CVRT has already garnered 22. For some further context, CSQ has 5.1k, CHI is at 4.9k, and CHY is at 4.63k. At this point, CVRT is really light on assets as they just launched, coming in at just over $5 million, according to Seeking Alpha. However, as an ETF, if it becomes popular, it can continually grow its AUM over time, unlike its CEF counterparts, which don't have as straightforward of a path to accumulate assets. CCVIX runs with around $882 million in assets.

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