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By Courtney Goethals Dobrow | 06-29-2010 03:17 PM

Calamos: Still a Valuation Gap in Convertibles

Calamos founder and manager John Calamos Sr. says that although the asset class isn't as beaten down as it was in 2008, valuations are still attractive.

Courtney Dobrow: A lot of the discussion around convertible centers on valuations that I know you saw probably once-in-a-career types of valuations in the middle of 2008 and I know that's coming in a little bit since then. What does the valuation landscape look like today?

John P. Calamos, Sr.: Well, again, the valuation in a recession period, it has got back to that normal period, which is still undervalued, so we're not in an overvaluation. And when people talk about valuation, they're really talking about the optionality of the convertible, you know, the fair value to undervaluation.

It did get abnormally low in 2008. It bounced back to normal type of valuations – undervaluations that I've seen in prior recessionary periods, which means that there is still a valuation gap. It wasn't as extensive as it was in '08, but there is still a gap. So that can provide some additional return for the investors.

In the sideways market, fair value on convertible should be look at reversion to the mean. It typically reverts to normal value somewhere along the way.

Dobrow: Is valuation something that the average investor, who has invested in a convertibles fund, is that something that they should even be thinking about ...

Calamos: Well, it is complex, valuations, when you talk to different analysts in a convertible area. Everyone can come up with a different fair value number. There is a lot of assumptions in any type of valuation that goes into that. That's why we do all our own research in-house. We do our own valuations.

So we understand if we get a call from a trading desk, they'll tell us, hey, this convertible is undervalued and then we'll look at it in our system and it's overvalued. So, you know, you have to do your own homework. I think it would be a bit difficult for individual investors to have that depth, even if they understood it, to really have the time and toolkit to go through that.

Dobrow: Can you talk a little bit about how you are evaluating companies' capital structures and how you're making the decision to buy the convertible or the bond or the stock and then how that is also blended with your macro viewpoint?

Calamos: Yeah. First, you know, we are – and maybe it's the way we have evolved over the last 30 years or so. But to be a good convertible portfolio manager, you have to understand the credit. So, now you have to look at the company from the credit point of view.

And then, because convertibles are equity, that's where you get your upside. You want to understand the equity, so we have evolved in a very holistic way in which we look at the company. We look at the whole company whether it has a convertible or not, but we want to look at the debt. We want to look at the balance sheet. We want to look at the income statement.

And what we're striving to do is come up with an intrinsic value of what this company would be worth if it were a private company. And then, when we're comfortable with that intrinsic value, we compare it to the market price, and we're also coming up with that by sector, by industry, how does it look compared to other companies, what's its return on capital. So it's a very detail process we're doing.

The way it impacts our top-down view is our top-down macro view of how we think the world is working leads us to either underweight or overweight typical sectors. And so, you have – right now we think that technology companies are positioned to do well in this current environment, then our bottom-up is, let's find the best ones in that area.

And if we don't like a sector very much, we've always had the attitude that we don't go to a zero rate weighting, we'll have some participation in that sector. A couple of reasons; keeps your head into the sector because things are changing all the time. And then what we do is, we want the best companies, even if we're underweighting the sector. So that's how our bottom-up work flows into that.

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