Yield-hungry investors have plunged money into all corners of the bond market, making it difficult to find attractive options. But one niche still offers value, yield and potential upside.–The Editors

In the May 2010 issue we profiled Fidelity Convertible Securities (FCVSX), a fund whose portfolio included a mix of common stocks, convertible bonds and preferred shares.

Most convertible securities are bonds or preferred stocks that pay regular interest but can also be converted into shares of common stock if they reach a predetermined price.

Although yields on convertible securities tend to be lower than those offered by traditional bonds, this asset class provides exposure to rising share prices.

Unlike convertible bonds, the stock variety doesn’t feature a fixed maturity date when an investor will receive his or her principal.

Fidelity Convertible Securities is still an excellent option, but Northern Income Equity (NOIEX) will benefit more if equities markets rally in the fall.

Jackie Benson assumed the reins as the fund’s sole manager in May 2009 after sharing the duties with Ted Southworth for two years. Benson’s investment process begins with a database of roughly 1,500 names that meet the fund’s pricing requirements. Her strategy focuses on companies with an identifiable catalyst to drive earnings growth or those that have fallen out of favor because of a short-term setback.

Once Benson decides to invest in a particular company, she then compares the payout offered by the convertible shares to the dividend on the common stock, as well as the relative risk and upside potential.

This risk-reward analysis means that the fund’s allocation to convertible securities can vary widely; at present, the asset class accounts for about a third of the portfolio. 

Benson tends to avoid busted convertibles, a class that offers higher yields but aren’t as attractive because they trade at a significant discount to the conversion price. She favors convertibles whose price action tends to mirror that of the corresponding common stock; these shares usually offer superior leverage to a stock market rally.

This strategy has led Benson to invest heavily in health care (16.7 percent of investable assets), consumer goods (16 percent) and energy (13.4 percent).

Although common stocks currently account for almost two-thirds of the portfolio, convertible bonds dominate the fund’s top positions. Leading the pack is Newmont Mining Corp 1.625% Convertible due July 2710, a private-placement deal issued by the world’s second-largest gold producer.

Management’s flexibility to shift between common stock and convertibles–not to mention Benson’s experience and savvy–has enabled the fund to outperform and limits volatility. Focusing on the risk-reward profile of the fund’s holdings also provides a great deal of downside protection in weak markets.

Northern Income Equity’s returns rank in the top 17 percent of its category on a five-year basis and in the top third on a three-year basis. With a solid track record and a 2.5 percent yield, the fund is a good bet for income-oriented investors.–Benjamin Shepherd

WHY TO BUY

NORTHERN INCOME EQUITY (NOIEX)

*Flexible asset mix allows the fund to benefit from equity rallies

*Abundant downside protection in case of market weakness

*Equity-like yields