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Alternative Market Briefing

Other Voices: Convertible bond arbitrage, 2009 and beyond

Monday, June 01, 2009

This article was written by Bryan Goh, First Avenue Partners LLP, London: Convertible arbitrage has been one of the best performing hedge fund strategies year to date in 2009, up 17.9% while the HFRI general index has gained 4%.

Recall, however, that convertible bond arbitrage was one of the worst performing strategies in 2008 losing 33% while the HFRI general index lost 19%. The losses came from a confluence of general risk aversion, deleveraging by banks and institutions, hedge fund redemptions and failures from over-levered portfolios, and a collapse in the funding mechanism. So acute was the risk aversion that convertibles were sold down regardless of issuer fundamentals or credit quality. Such sell-offs naturally create opportunities for the astute investor as idiosyncratic risk is mispriced by a market on the one hand, and systemic risk is overpriced by the market on the other, in the midst of market panic.

It is natural therefore that once the acute and broad based risk aversion had reached its zenith, convertible bonds would represent exceptional value and rebound. The last 4 months have seen this occur in a reversion of the systemic risk trade. Convertible bonds have rallied across the board with demand coming from fundamental credit investors, hedge funds, corporates and issuers buying back their own bonds. Notably absent or at best......................

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