CONVERTIBLES
The CWB Convertible ETF
Summary
Recently, the first convertible ETF was launched - the newly launched SPDR Barclays Venu Krishna, CFA
Capital Convertible Bond ETF (Bloomberg Ticker: CWB US Equity). It is offered by State Head of EQ-Linked Strategies
+1 212 526 7328
Street Global Advisors with the aim of providing access to the convertible bond market venu.krishna@barcap.com
to a broad base of investors. The Fund is designed to track the performance of the BCI, New York
Barclays Capital U.S. Convertible $500MM+ Index. It first started trading on April 16 and
currently has a market cap of $31 million. Manoj Shivdasani, CFA
Convertible Research
+1 212 526 5995
In this report we provide an overview of the basic aspects of CWB, including ETF
manoj.shivdasani@barcap.com
mechanisms regarding purchase and redemption of Creation Units, Fund BCI, New York
characteristics and holdings, as well as its performance relative to the Barclays Capital
U.S. Convertible $500MM+ Index. Peng Cheng
Convertible Research
We find that based on its net asset value (NAV) returns, since inception, CWB has a +1 212 526 8432
peng.cheng1@barcap.com
correlation of 0.88 with the Barclays Capital U.S. Convertible $500MM+ Index. We also
BCI, New York
conduct back test based on the current fund holdings over 1 year history and find the
hypothetical correlation to be 0.96.
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Introduction
The purpose of this report is to provide an overview of the newly launched SPDR Barclays
Capital Convertible Bond ETF (Bloomberg Ticker: CWB US Equity). It is offered by State
Street Global Advisors with the aim of providing access to the convertible bond market to a
broad base of investors. The Fund is designed to track the performance of the Barclays
Capital U.S. Convertible $500MM+ Index. It first started trading on April 16 and currently has
a market cap of $31 million.
The Barclays Capital U.S. Convertible $500MM+ Index is a member of the U.S. Convertible
Indices and includes securities that fit the following criteria:
1. Minimum of $500 million size outstanding (or accreted face value for Zeros/OID)
At any point in time, the Barclays Capital U.S. Convertible $500MM+ Index contains two
separate universes of data: Returns and Statistics. The returns universe is set at the
beginning of each month and remains static for the entire month. If a security falls out of
the Barclays Capital U.S. Convertible $500MM+ Index during the month (falls below
minimum size outstanding, defaults, is called, etc.), it will still contribute to returns for the
existing month but will be absent from the following month’s returns.
On the other hand, the statistics universe is based on a dynamic set of securities that
change according to index criteria. If a security fails to meet the minimum index criteria, it
will drop out of the statistics universe (but will still contribute to end of month returns data).
Also, securities that meet the minimum index criteria, including new issues, may enter the
Statistics universe during the month but will not contribute to returns for that month.
Therefore, the number of securities comprising the statistics universe will often differ
slightly from the returns universe.
As of 05/12/2009, the Barclays Capital U.S. Convertible $500MM+ Index contains 134
issues and all four major classes of convertible securities (i.e. cash pay bonds, zeros/OIDs,
preferreds and mandatories) with a market value of around $110B. Index data is updated on
a daily basis. All returns are market value weighted. Total return will be the sum of price
return plus coupon return. Year to date, the Barclays Capital U.S. Convertible $500MM+
Index has delivered a total return of 16.75% compared with the S&P 500 YTD total return of
1.57%.
Figure 1 and 2 below show the proportion of Barclays Capital U.S. Convertible $500MM+
Index relative to the Barclays Capital U.S. Convertible Composite Index (a proxy for the
whole U.S. convert market). The securities in the Barclays Capital U.S. Convertible $500MM+
Index represent 20% of the Composite Index in terms of number of securities, but 54% in
May 13, 2009 2
Barclays Capital | Convertibles Research
terms of market value. Figure 3 demonstrates the strong performance of many outright
funds YTD, as well as Barclays Capital U.S. Convertible Composite and $500MM+ Indices.
Figure 1: Barclays Capital 500M+ U.S. Convertible Index Figure 2: Barclays Capital 500M+ U.S. Convertible Index
Securities vs. Composite Index Market Value vs. Composite Index
Barclays Capital U.S. Barclays Capital Barclays Capital U.S. Barclays Capital U.S.
Convertible Composite U.S. Convertible 500M+ as % of Convertible Composite Convertible 500M+ 500M+ as % of
Securities 500M+ Securities Composite Values Values Composite
Cash Pay 554 94 17% Cash Pay 156.49 79.324 51%
Mandatories 23 13 57% Mandatories 11.94 10.025 84%
Preferreds 78 23 29% Preferreds 25.69 18.023 70%
Zero/OID 27 3 11% Zero/OID 6.62 2.01 30%
Total 682 133 20% Total 200.74 109.382 54%
Figure 3: Outright Convert Funds Top Performers % Returns YTD (Assets at least $200M)
A link to the Barclays Capital U.S. Convertible $500MM+ Index can be found on Barclays
Capital Live by selecting the Equities tab, then “Convertible Bonds”, and then “U.S. Convert
Index”. Alternatively, it may be accessed by selecting the Indices tab, then “Benchmark
Indices”, followed by “U.S. Convertibles”.
In other words, to create (i.e. purchase) Creation Units, the investor must deliver to the
Authorized Participants a specified portfolio of securities, instead of cash. The content of the
portfolio is at the discretion of the Fund and need not be similar to the Fund holdings. For
CWB, it should be a substantial replication of the Fund holdings, according to the
Prospectus. In order to redeem, the investor can aggregate ETF shares into Creation Units,
then exchange for the portfolio of underlying securities. The underlying securities of the
Creation Units are published daily to the Authorized Participants before market open.
Redemption Creation
Investor B Investor A
Underlyings Underlyings
Creation Units
Authorized Authorized
Participant B Participant A
CWB
Since the Net Asset Value (NAV) of the Fund is determined daily, and the creation and
redemption can occur as frequently, any large discount or premium of the fund value and
NAV should not be sustained, otherwise arbitrage is possible. If the ETF price is higher than
the NAV, one can buy the underlying securities, deposit them in exchange for the Creation
Units, then sell the ETF shares in the open market. On the other hand, if the ETF price is
lower, one can buy the ETF shares, aggregate them into Creation Units, redeem them for
underlying securities, and sell the underlying securities at NAV. In practice, however, the
liquidity of the underlying securities may also cause some differences in the NAV and ETF
price to persist.
The portfolio consisted of 38 securities or about 29% of the total securities in the Barclays
Capital U.S. Convertible $500MM+ Index. However, they represent about 44% of the market
value of the universe. Figures 2 and 3 break down the percentages by security types. We
believe it is reasonable to expect that as the size of the Fund grows, the holdings will also
expand going forward.
The Fund also provided breakdown by quality and maturity. See Figures 6 and 7 for the
information and comparison with the Barclays Capital U.S. Convertible $500MM+ Index. As
the figures show, the Fund closely matches both the credit quality and maturity of the
Barclays Capital U.S. Convertible $500MM+ Index.
The goal of the Fund is to mirror as closely as possible the total return of the returns
universe (recall differences may exist between returns and statistics universe of the Barclays
Capital U.S. Convertible $500MM+ Index). As per our understanding, adjustments to the
portfolio will be made throughout the month as needed, given cash uses/needs, trading
liquidity, and other factors. Since the Barclays Capital U.S. Convertible $500MM+ Index
returns universe is rebalanced every month, we believe it is reasonable to expect the Fund to
rebalance at least monthly.
Further information and fund literature can be found on the SPDR website
http://www.spdrs.com.
Figure 6: CWB Securities vs. Barclays Capital $500M+ U.S. Figure 7: CWB Market Value vs. Barclays Capital $500M+ U.S.
Convertible Index Convertible Index
Source: Barclays Capital, State Street Global Advisors Source: Barclays Capital, State Street Global Advisors
The Fund currently has a market cap of $31 million. The size of the Fund has grown rapidly,
driven primarily by the increase in shares outstanding. There are 1,000,000 shares
outstanding as of 05/12/2009, compared to the 200,000 shares at inception.
Figure 10: Price and Shares Outstanding Figure 11: Cumulative Returns Since Inception
5/11
5/12
5/1
5/4
5/5
5/6
5/7
29 5/8
-1.0%
100
28.5 0 -2.0%
4/16 4/20 4/22 4/24 4/28 4/30 5/4 5/6 5/8 5/12
-3.0%
Shares Out (x000) CWB NAV CWB NAV Index Tracking Error
The performance of the Fund can be evaluated against its stated objective of achieving a
correlation of at least 0.95 with the Barclays Capital U.S. Convertible $500MM+ Index. We
look at the NAV of the Fund instead of the price, since the price may be subject to market
conditions outside of the Fund’s control. Based on the 18 daily return data points since
inception, the correlation of the Fund NAV and the Barclays Capital U.S. Convertible
$500MM+ Index is about 0.88.
Figure 12: Fund NAV Daily Returns vs. Index Returns Since Inception
2.00
1.50
1.00
0.00
-4 -3 -2 -1 -0.50 0 1 2
-1.00
-1.50
-2.00
-2.50
Index Returns (%)
The existing time series is not sufficiently long to accurately measure the correlation. Still,
we can rely on historical data for back testing purposes, subject to some simplifying
assumptions. We assume that we initiated a portfolio with the same members and
weighting as Figure 5 a year before inception (04/16/2008). Assuming the portfolio was
static for one year with no rebalancing, the correlation of daily returns turns out to be 0.96,
as Figure 13 shows. Interestingly, even if only the top 10 holdings were taken to the back
test, the correlation still comes out to be about 0.90. We believe the estimate is conservative
because the portfolio was completely indifferent to index changes and movements. If the
portfolio was actively managed, as in the case of the Fund, we would expect the correlation
to be at least as high. Nonetheless, results from back testing may not accurately predict
future performance.
2
NAV Returns (%)
0
-8 -6 -4 -2 0 2 4 6
-2
-4
-6
-8
Index Returns (%)