Convertible bonds offer access to two otherwise separate security markets. They start out as corporate bonds, which are debt instruments that carry the normal attributes of bond offerings: protection of principal, income generation and favorable position in a bankruptcy situation. If certain criteria are met, the holder of the bond may convert the corporate bonds into common stock of the issuing company. This allows investors flexibility in terms of equity appreciation or an escape from interest rate risk.

Mutual fund investors cannot gain access to all of the features of convertible bonds. Most mutual funds are organized as open-ended investment companies that issue equity shares; these shares are not themselves convertible. Instead, convertible bond mutual funds act like balanced mutual funds with both stocks and bonds. They emphasize equity upside and income simultaneously. They also tend to hold smaller, riskier companies than balanced funds.

From a practical perspective, convertible bond portfolios offer the potential of capital appreciation, like stock portfolios, without completely losing the safety or income potential of bond portfolios. It is important to remember a convertible bond mutual fund is still an equity, so there is no guaranteed return of principal like with an actual bond. Investors wanting maximum safety should consider investing in real debt instruments before turning to a convertible bond mutual fund.

Heading into 2016, all mutual fund investors should keep an eye on the Federal Reserve's decisions regarding interest rates. The United States has been in a historically low interest rate environment for seven years, providing a boon to equity markets but stymieing yields for income investors.

Some of the funds selected are intentionally identified as investor class, even though this can be misleading. The majority of shareholders in mutual funds hold "class A" shares, which come with the standard initial sales charges. That said, those with access to advisor shares should understand their options and take advantage of funds that perform particularly well through that prism.

AllianzGI Convertible Fund

Issuer: Allianz Global Investors

Assets Under Management (AUM): $2.19 billion

2015 Year-to-Date (YTD) Return: -3.40%

Expense Ratio: 0.97%

The strongest long-running performer in the convertible securities space is the AllianzGI Convertible Fund. It is a low-fee, moderately risky mutual fund that invests in U.S. corporate fixed-income securities or any other security that provides a chance of future equity participation. These include debentures, convertible hybrid notes and preferred stocks, but also warrants, options and other less traditional securities with higher upside potential. The fund offers a potentially bumpy ride, at least by convertible security standards, but it is as well suited as any in the segment to offer protection against rising prices in a low-rate environment.

RBC BlueBay Global Convertible Bond Fund

Issuer: RBC Global Asset Management

AUM: $21.56 million

2015 YTD Return: 3.14%

Expense Ratio: 0.85%

The RBC BlueBay Global Convertible Bond Class I Fund invests in either convertible bonds or warrant-linked bonds of issuers who are in at least three countries. This limits exposure to larger issuers with an international focus, although the fund allows up to 20% of assets to be invested in equities. Morningstar lists the convertibles portfolio as large value, meaning it concentrates on large issuers focusing on value. Fees and risk are low, even for the segment. The fund earns a Lipper Leader designation for capital preservation, although it lags in several other categories. The real net all-in costs are closer to 1 than 0.85%.

Victory INCORE Investment Grade Convertible Bonds Fund

Issuer: Victory

AUM: $51.40 million

2015 YTD Return: 0.29%

Expense Ratio: 1.00%

Like The RBC BlueBay Global Convertible Bond Fund, the Victory INCORE Investment Grade Convertible Bond Class I Fund is made up of bonds from large, value-selected issuers. The Class I funds are much cheaper and more efficient than the Class A funds, as is the case with many bonds. However, even the 1.52% expenses for A shares is low and its performance is reasonable.

There are only three sectors present in this portfolio: utilities, industrials and consumer defensive. Utility issuers make up greater than 60% of all assets, which adds a degree of dividend reliability. Utilities have notoriously docile movements, so this strategy also drives down risk compared to dissimilar competitors.

Franklin Convertible Securities Fund

Issuer: Franklin Templeton

AUM: $2.01 billion

2015 YTD Return: -2.60%

Expense Ratio: 0.88%

The Franklin Convertible Securities Fund has a long and successful track record, and it is one of the most recognizable convertible mutual funds. It holds roughly 75 convertible bonds or preferred stocks, although there is the breadth to invest in common stock in small amounts. It consistently outperforms its category average and ranks in the top 20% over 10-plus years and has been in the top 10% since 2014.

Fidelity Convertible Securities Fund

Issuer: Fidelity

AUM: $2.06 billion

2015 YTD Return: -7.12%

Expense Ratio: 0.85%

For investors with a little more risk tolerance, the popular Fidelity Convertible Securities Fund generally outperformed the segment following the 2008 recession, although it has struggled since early 2015. It trades free on the Fidelity platform and otherwise carries very low costs for a convertible bond fund. This mutual fund focuses on the speculative-grade portion of the market, and uses equity leverage to boost returns whenever management sees an opportunity. The philosophy is fundamental and tilts toward value plays but leans away from the utilities and health care sectors that can make it even more volatile.

Harbor Convertible Securities Fund

Issuer: Harbor Funds

AUM: $378.4

2015 YTD Return: 1.40%

Expense Ratio: 0.75%

An institutional class choice, the Harbor Convertible Securities Fund Class I is a low-cost, slow-and-steady junk bond choice for potential rough markets ahead. It had paced the market in 2012 and 2013 but fell behind in a serious way over the next 18 months when a higher-risk environment fueled higher growth for many below-investment grade competitors.

More than 80% of coupons in the portfolio pay in the 0 to 4% range, which is significantly above the category average. There is an even larger tilt toward American issuers and short-term issues, which should play reasonably well in a rising rate environment.

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