Q3 | 2012Putnam Convertible Securities Fund Q&A

Making the most of the rally with less of the risk

Eric N. Harthun, CFA Portfolio Manager Robert L. Salvin Portfolio Manager

The opportunity in convertibles is nicely balanced between yield and capital appreciation potential, as well as between supply and demand.

Key takeaways Convertibles had a strong third quarter, driven by positive gains in stock and corporate credit markets. Convertibles offered competitive returns versus equities and bonds during the quarter. New issuance of convertible securities is picking up, which is broadly positive for the sector and a convertibles-focused investment approach such as Putnam Convertibles Securities Fund. How would you describe the convertibles market during the third quarter? Convertibles entered the third quarter balanced between offering attractive current yield and capital appreciation potential, and were somewhat cheap on a historical basis. The resulting performance for the asset class was strong, driven by the dual tailwinds of healthy performance among equities and corporate credit. Balanced convertibles are particularly attractive in that they offer investors a good portion of the underlying equities appreciation and the potential to receive an attractive yield and i.e., a balance of upside participation and downside protection. Through the quarter, investors became more confident that a solution or at least a major step toward the ultimate solution to the European debt crisis was at hand. As we came out of the summer, the tone was more balanced than it had been in the previous quarter between optimism and concern over the still-present sovereign debt problems. Equity markets continue to reflect worries, however, over data out of China, where growth has disappointed and may be a risk for a continued slowdown. Having said that, convertible securities held up well for the quarter overall, providing an attractive total return when compared with that of straight equities and bonds.

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Have companies been issuing more convertibles to finance their operations? New issuance picked up nicely in the third quarter, though it is still lower than normal on a historical basis. As equities appreciated and corporate credit spreads narrowed, companies in a number of industries began to issue more convertible debt. Homebuilders became one of the more prevalent issuers of convertible securities, and we found what we consider excellent value among new issuance in financials, biotechnology, and technology. Overall, the environment remains positive for a continuation of this trend because stock prices in general seem firm and interest rates have the potential to rise. From the perspective of debt-issuing companies, convertibles are simply becoming more attractive on a relative basis. In addition, companies are beginning to issue convertible bonds for shareholder-friendly reasons such as stock repurchases. Could you describe your approach to finding the most attractive convertible securities? There are several areas of inefficiency in the convertibles market that we seek to take advantage of in the fund. First, we often find securities that are mispriced from a credit perspective. Second, the underlying equity can frequently be misunderstood or not well followed by industry analysts. The third area revolves around the basic structure of convertibles, which can be somewhat complex. We like to say that no two convertibles look exactly alike. But analysts frequently fall into the trap of misunderstanding the structural characteristics of convertibles, and failing to appreciate how the idiosyncratic nature of each security can lead to mispricing and, hence, attractive investment opportunities. When we analyze a convertible security, we try to locate the key factors that are driving its pricing. It might be a set of fixed-income factors or a set of equity-related factors, for example. Once we feel confident about the source of pricing or mispricing, we bring the appropriate credit or equity research resources to bear in our analysis and portfolio decision-making.

Does the prevailing low interest-rate environment make you more or less optimistic about the performance potential of convertibles going forward? A common misperception of the convertibles market is that the returns of these securities are more dependent on interest rates than other factors. Over time, data have suggested that convertibles are driven more by the strength or weakness of the equity markets and corporate credit spreads. And because they are short-duration instruments, there is generally a low correlation between their performance and interest-rate movements. So, while low rates do matter for a variety of asset classes, rates are less relevant to convertibles performance. In looking at the four most recent rising-rate environments in 1988, 1994, 19992000, and 20042006 higher rates, economic expansion, and equity market strength led to good performance for convertibles. What is your outlook for the economy and convertibles market? We are constructive on the convertibles market, though sources of uncertainty remain. Areas of concern include the coming U.S. election and the approach of the fiscal cliff, in addition to the macro issues that continue to beset Europe or threaten to become even more pronounced in China. Despite these issues, there is much to feel positive about with respect to convertibles. The fixed-income backdrop is broadly positive for convertibles looking forward. We think that corporate credit spreads may remain relatively stable or have a slight tightening bias, particularly in the high-yield market, where we are at or just above historical average spreads. From an equity standpoint, we see corporate earnings improving into 2013 at a moderate but still positive pace. Whats more, we feel the underlying equities of the convertibles in the portfolio of Putnam Convertible Securities Fund have good growth prospects. We have seen a long wave of corporate restructuring, including headcount reductions and channel rationalizations designed to improve corporate profitability and efficiency. All of these fundamental factors bode well for debt and convertible markets, in our view.
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Q32012| Making the most of the rally with less of the risk

Putnam Convertible Securities Fund (PCONX)

Annualized total return performance as of September 30, 2012 Class A shares (inception 6/29/72)
Last quarter 1 year 3 years 5 years 10 years Life of fund Total expense ratio: 1.12%

Before sales charge

5.76% 16.48 9.81 2.47 8.78 9.83

After sales charge

-0.33% 9.81 7.67 1.27 8.13 9.66

BofA ML All U.S. Convertibles Index

4.92% 16.63 9.48 2.90 7.92

Current performance may be lower or higher than the quoted past performance, which cannot guarantee future results. Share price, principal value, and return will vary, and you may have a gain or a loss when you sell your shares. Performance of class A shares before sales charge assumes reinvestment of distributions and does not account for taxes. After-salescharge returns reflect a maximum 5.75% load. A short-term trading fee of 1% may apply to redemptions or exchanges from certain funds within the time period specified in the funds prospectus. To obtain the most recent month-end performance, visit putnam.com. Quarterly returns are cumulative. The Bank of America (BofA) Merrill Lynch All U.S. Convertibles Index is an unmanaged index of high-yield U.S. convertible securities. You cannot invest directly in an index.

The views and opinions expressed are those of the portfolio managers, as of September 30, 2012. They are subject to change with market conditions and are not meant as investment advice. Consider these risks before investing: The prices of convertible securities in the funds portfolio may fall or fail to rise over extended periods of time for a variety of reasons, including both general financial market conditions and factors related to specific companies or industries. These risks are generally greater for convertible securities issued by small and midsize companies. The prices of convertible securities may be adversely affected by changes in the prices of underlying common stocks. Convertible securities tend to provide higher yields than common stocks. However, a higher yield may not protect investors against the risk of loss or adequately mitigate any loss associated with a decline in the price of a convertible security. Convertible securities are subject to credit risk, which is the risk that an issuer of the funds investments may default on payment of interest or principal. Credit risk is generally greater for below-investment-grade convertible securities. Generally, convertible securities may be less sensitive to interest-rate changes than non-convertible bonds as a result of convertible securities structural features (e.g., convertibility, put features). Interest rate-risk is generally greater, however, for longer-term bonds and convertible securities whose underlying stock price has fallen significantly below the conversion price. Request a prospectus or summary prospectus from your financial representative or by calling 1-800-225-1581. The prospectus includes investment objectives, risks, fees, expenses, and other information that you should read and consider carefully before investing.
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