Hedge funds return to bond trade with checkered past

NEW YORK: A surge in issuance of a type of bond that can convert into stock on maturity is helping revive a hedge fund strategy that was crushed during the financial crisis.

So-called convertible arbitrage, in which investors try to capitalise on price discrepancies between a convertible bond and its underlying stock, attracted inflows in the first quarter as investors pulled billions out of other strategies, according to data from Nasdaq eVestment.

A typical trade involves taking a long position on a convertible bond and a short position on the underlying stock. If the share price falls, investors profit from the short. If it gains to a certain level, they can convert the bond into equity on maturity.

It’s win-win unless refinancing concerns cause a sudden slump in the bond price.

“The strategy returned 4.4% in the first four months of 2024, outperforming other relative value strategies,” according to Hedge Fund Research.

It’s set for another boost as companies look to extend maturities on more than US$200bil of convertible bonds due in the next five years.

Other firms are entering the market for the first time, attracted by interest rates that are lower than on conventional debt, and encouraged by stock prices near historic highs.

The favourable conditions are already boosting hedge fund performance. US-based convertible arbitrage-focused hedge fund Linden Advisors gained 5.8% from the start of the year through April, building on gains in 2023 of nearly 12%, according to a person familiar with the matter.

Context Partners, which also specialises in the strategy and manages around US$1.7bil of assets, gained more than 6% through May 10, according to a document seen by Bloomberg News.

Man Group Plc, the world’s largest listed hedge fund, is increasing its exposure to the strategy via its External Alpha team, according to chief investment officer Adam Singleton. — Bloomberg