Commentary

Convertibles remained resilient in February with a 0.6% decline in the Merrill Lynch All Convertible Index (VXA0) compared with a 3.3% fall in the S&P 500. Year to date, convertibles fell 2.5%, less than the 9.1% decline in the S&P 500. The markets continue to be driven by concerns over liquidity, stresses on the balance sheets of banks, the possibility of recession, inflation and mortgage defaults. Convertibles, as has been shown in recent months, can limit risk of loss in down markets. They also tend to participate in returns when the stock market rises.

Investors have been skittish lately, as evidenced by a strong  uptick in volatility as measured by the Chicago Board Options Exchange VIX Index.* As noted by JP Morgan, the VIX had an average closing price of nearly 26 in the month of February, far exceeding the 17.5 average in all of 2007 and a measure of 20.8 during what was a more volatile second half of the year. Volatility often benefits convertible values because larger movements in the underlying equities tend to make the option for conversion embedded in a convertible bond more valuable.

Credit Quality

The Merrill Lynch All Speculative Grade Index (VXA2) outperformed the All Investment Grade Index (VXA1) by 20 basis points, though the speculative bonds' returns so far this year are still well behind those with investment-grade ratings. (Investment-grade convertibles on the whole outperformed speculative-grade since mid-2007.) Calamos is biased toward high-quality convertibles from issuers with low debt and strong growth prospects.

Issuance

While issuance slowed in February, this year's net issuance (which factors in redemptions) is at $5.8 billion after banks and brokerages in January came to the market with large convertible sales. Half of the $2 billion in gross issuance in February also came from financial companies looking to convertibles to shore up their balance sheets. The average yield of new convertible issues in February was 4.8% compared with 3.3% in the All Convertible Index.

Sector Performance

The energy and materials sectors continue to be fueled by record prices for agricultural commodities and oil, causing both sectors to sharply outperform the rest of the convertibles universe. The sectors also were the best performers in all of 2007. We believe valuations of commodities companies appear high and their securities tend to be volatile. Potentially, many commodities companies may be at their peak earnings. The industrials and consumer staples sectors managed to end in positive territory while the rest of the sectors all retreated.

Outlook

From the S&P 500's market high in October (10/09/2007), the broad market has now declined 14%. Uncertainty and market volatility are likely to continue as investors remain nervous about the credit markets, the banking system and the broader economy. However, we feel the economy's fundamental factors such as export strength, healthy profit from non-financial sectors, and the relatively low unemployment rate remain intact. We believe the current market decline has already priced in a recession to a large extent. The results from the recent market correction should remind investors the importance of accurately identifying secular trends and investing in companies with sustainable growth and strong balance sheets.