How Fidelity Convertible Securities Fund Wins Big With Hybrid Bonds

Adam Kramer and Rick Gandhi manage a bond fund that posted a higher return than the S&P 500 last year. And its track record makes it one of the best mutual funds.

Fidelity Convertible Securities fund (FCVSX) gained 18.4% in 2025, topping the U.S. equity market benchmark’s 17.8% gain.

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How did they do it? Kramer and Gandhi invest in an asset class — convertible bonds — that offers the income and downside protection of a bond but also the upside potential of a stock.

These hybrid corporate bonds pay a fixed yield that acts as a bond floor. But they also give investors the right to convert the bond into shares of stock. So, if the stock price rises above the so-called conversion price set out in the bond’s offering documents, Kramer and Gandhi can convert the bond to stock and profit from capital appreciation, too.

“What’s unique about this type of security is it has an equity conversion feature that allows the investor to participate in the equity upside,” said Kramer. “Convertible bonds are the only fixed-income security where you can double, triple, quadruple or quintuple. Or in the case of Hall of Fame convertibles (or biggest returners in history) you can earn 10, 11, 12, or 13 times your money. You can have a lot of potential upside with the downside protection of a bond.”

Convertible Bonds Make For Best Mutual Funds

Investing in convertibles means Kramer and Gandhi, with the help of Fidelity’s army of fixed income and equity analysts and portfolio managers, must scrutinize both the credit quality of a company as well as the company’s growth prospects.

“We are both bond investors and stock investors,” said Gandhi. “Sometimes the market is asking us to wear our credit investor hat, and sometimes it’s asking for the equity investors hat.”

Like most investments, there’s no guarantee that a convertible bond will produce a positive return. Since a convertible fund’s holdings are priced at current market values, factors such as declining stock prices, widening of credit spreads, and rising rates can result in a negative total return over various time periods. And that’s true despite the bond-like downside protection a convertible bond offers.

If the stock doesn’t rise above the conversion price and, therefore, is “out of the money,” losses can follow if the bond itself loses value.

“The first rule for us is to be very, very diligent on our bond analysis and make sure we do not lose money,” said Gandhi.

Best Mutual Funds Manage Risks

Kramer and Gandhi must balance the risk and reward of both the fixed-income and equity component of the securities they buy.

And they’ve done a consistent job of doing that. Fidelity Convertible Securities fund has topped the Bloomberg US Aggregate Bond index, which tracks the performance of investment grade bonds and which IBD uses as a benchmark when measuring fixed-income performance, in the past one, three, five and 10 year periods, as of the period ended Dec. 31. The fund has also topped the index it tracks, the ICE BofA All U.S. Convertibles index, in all those time periods as well, according to Fidelity.

The fixed rate of return, or so-called bond floor, on convertible bonds is roughly 3%, on average, according to Kramer. That’s lower than the yield you’d get on a high-yield bond and a tad below the interest on an investment grade bond. But that lower yield is what you accept in exchange for the equity upside.

Still, that 3% yield matches up quite well with the duration of a typical convertible bond, which is about two years on average, Kramer says.

Convertibles Are Unique Stock Market Plays

Managing a convertible bond fund that tracks the ICE BofA All U.S. Convertibles index is a bit different than tracking other indexes, says Kramer. Why? There’s less “regression to the mean” risk, or the tendency for assets that have performed exceptionally well or poorly to eventually revert back to their long-term average performance.

That’s because the index is frequently refreshed with new issues that represent different investment themes and equity styles. The ICE BofA All U.S. Convertibles index is rebalanced monthly, with turnover of 5% to 10%, on average. New issues replace older ones that are removed from the index due to credit downgrades pushing them below investment grade, bonds called by issuers and bonds that are converted to common stock.

Best Of Both Worlds?

Convertibles also benefit from their “best of both worlds” bond and stock exposure. They don’t always revert to the performance of either a pure bond or a pure stock.

“That benchmark index today is a lot different than it was two, three, four years ago,” said Kramer. “And the industries are changing all the time. It’s really driven by the new issues market.”

The managers of Fidelity Convertible Securities boost the fund’s performance by identifying new issues with a winning combination of solid credit metrics and business fundamentals and growth potential. These traits can boost an issue’s share price well above the so-called conversion price, which at the end of 2025 was 35.8%, according to Calamos Investments. For example, if a stock trades at $100 per share and the conversion price is $135.80, the fund makes money if the stock rises more than the 35.8% conversion rate.

Looking For 10 Baggers

Kramer and Gandhi look to identify big equity winners, such as so-called “10 baggers,” or stocks whose value grows 10-fold.

“It’s very important to be able to capture these potential winners,” said Kramer. “We like to call them lions. And we call the new issue market a basket of kittens. Our job is to look through those baskets of kittens and try to find that 10% or so that become the lions.”

Sometimes Kramer and Gandhi will hold a so-called lion in the fund even after it’s been replaced in the index.

Controlling Risk Is Critical

Still, the fund has tight risk controls geared to keep the fund’s beta, or level of risk versus the index, in line with the index, says Kramer. “A lot of these risk controls are put into place when a holding converts to equity,” said Kramer.

Oil tanker company DHT (DHT), a top 10 fund holding, is an example of a stock the fund still holds even though it is no longer in the benchmark index the fund tracks. DHT is unique in that it pays out 100% of ordinary net income to shareholders in quarterly cash dividends. Its trailing dividend yield is 5%, according to Morningstar.

“We like the story, we like the fundamentals, and it’s uncorrelated to (other parts of the market), so sometimes we use that type of holding as a portfolio construction tool,” said Kramer.

Understanding The Sensitivity

Convertibles have what is called “equity sensitivity.” This refers to how much the convertible moves for a 1% move in the underlying stock. When a convertible is purchased, sensitivity is often around 50%. That means if the stock moves up 40%, the convertible bond will move up 20%, says Gandhi.

In general, a convertible bond behaves depending on the stock price moves. If the stock lags or declines in value and is well below the conversion price, the convertible behaves more like a bond. If the stock nears the conversion price, the equity sensitivity rises, and the bond captures a good portion of the upside. When the stock rises far above the conversion price, the equity sensitivity nears 100%, and the convertible bond becomes more like a stock.

Typically, a convertible bond holder has up until just before the bond’s maturity to convert it to common stock. It may seem like a no-brainer to convert the bond to stock when there is capital appreciation to be had. But doing so also means you’re giving up downside protection, Gandhi explains.

“Our rule of thumb is that we will maintain the convertible bond as long as possible because that is giving us downside protection if things go wrong,” said Gandhi. “But the reality is if it starts to trade like equity, you can sell the convertible at the market value, you can convert it to equity, or you can keep it as a bond.”

Top Holdings Of A Best Mutual Fund

The fund’s top holdings are good examples of how the fund profits from the dynamic and changing nature of the ICE BofA All U.S. Convertibles index, Gandhi says. Consider top holding Western Digital (WDC), which pays an annual yield of 3% and matures on Nov. 15, 2028. Also think of Seagate HDD Cayman CV 3.35% (a subsidiary of Seagate Technology (STX)) which matures on June 1, 2028.

Gandhi says both companies have been high-yield bond issuers for a decade. And Fidelity’s analysts have covered both companies closely. Both companies once sold at cheap valuations because investors didn’t view the hard disk drive market as a growth market.

But AI changed that perception. And Fidelity’s analyst team saw the change coming. Now both companies are viewed as key players in the data storage space and buildout of AI. Now, Western Digital and Seagate are viewed as AI growth plays.

“Sometimes names sit in the index for a long time and don’t do anything, and then something changes in the market,” said Gandhi. “That’s exactly what happened with these two companies. People realized that we are going to need a lot more (storage). So Western Digital and Seagate have gone up many fold over the last 18 months.”

Riding Another Top Holding

Boeing (BA), the fund’s second-largest convertible holding, is another example of how changing trends can reinvigorate a company. The aerospace giant is using AI to aid military transportation and boost safety. When they came to market with their convertible and joined the index they were having some difficulty, Gandhi says.

“The (refreshing of the index) just gives us so many shots on goal,” said Gandhi. “When you look at the fund’s top holdings, you don’t really see one theme. It’s lots of different industries and different ways to generate attractive returns.”

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