Investors often overlook convertible securities because they don’t understand how these instruments work or don’t think they offer enough upside. Properly managed, convertibles have a place in any portfolio.

Convertible securities can be a tough nut to crack for individual investors, as these assets sometimes perform like stocks and sometimes perform like bonds. And they can be structured as preferred stocks or actual bonds. But regardless of the structure, the determining characteristic is that they can be exchanged for common stock in a company at predetermined levels.

Conversion terms present the biggest hitches to investors. Some are convertible on the holders’ option, others at the issuers’ option. Conversion can occur at a fixed date or prices. The sheer number of variables involved can make it difficult for investors to navigate the convertible universe; a professionally managed mutual fund is the best way to gain exposure to this asset class.

One of our favorites is Fidelity Convertible Securities (FCVSX). Although it’s been around since the late 1980s, the fund’s performance began to shine not long after Tomas Soviero took the helm in mid-2005. Since then, the fund has averaged an annualized return of better than 12 percent.

Although his skill with convertibles is obvious, Soverio’s analytical abilities regarding macro trends has been impressive as well. And he‘s not afraid to follow his instincts. Most notably, he maintained almost no exposure to financials in 2007; his one related play was Ventas (NYSE: VTR), a real estate investment trust with a portfolio of senior housing and health care-related properties, that returned approximately 21 percent in the back half of the year.

He’s also been known to play energy and metals aggressively, focusing on convertibles trading in price ranges that lead to behavior more typical of stocks than bonds. Names familiar to any commodity investor such as Peabody Energy (NYSE: BTU), El Paso Corp (NYSE: EP) and Freeport-McMoRan Copper & Gold (NYSE: FCX) form the bulk of his top positions.

In contrast to three years ago, financial names now make up over 40 percent of the fund’s portfolio. Sensing a shifting trend, Soverio has added to the fund’s financial exposure since mid-2009. Technology names have increased to 12 percent of investable assets, with a major focus on hardware names such as Intel (NasdaqGS: INTC) and Advanced Micro Devices (NYSE: AMD).

The major downside to Soverio’s approach is that the fund is more volatile than conservatively managed offerings. Given the manager’s current preference for stock-like convertibles, investors should expect fluctuations in the fund’s net asset value and greater sensitivity to the overall state of the energy commodities market. For example, the fund lost nearly half its value in 2008 only to soar more than 64 percent in 2009. Thus far, Soviero has maintained that outperformance; the fund ranks in the top 1 percent of its category this year.

But with Soviero’s nose for macro trends and decades of experience, he knows when to get in and when to get out. Still, the fund’s volatility can spook some investors; only individuals with fairly high risk tolerances should consider adding this fund to their portfolio. For those who can stomach the swings, the fund offers strong performance in bull markets.

Why to Buy
FIDELITY CONVERTIBLE SECURITIES (FCUSX)

• Experienced management team

• Offers exposure to energy commodities

• Good choice for aggressive investors