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Haywood: market now quite
appealing for convertible plays
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Hedge funds that invest in convertible bonds have posted their worst performance ever during the first five months of this year, but it could be the right time to get back into the market.
According to Hedge Fund Research, convertible arbitrage funds fell 6.73% on average in 2005 to the end of May. Tremont Capital estimates that in the first quarter of the year, investors withdrew about $1.8 billion from the strategies.
In addition in June a handful of managers admitted defeat. California-based Marin Capital, a convertible bond fund that at one time ran $1.7 billion, said it would be returning money to investors because performance was being pushed down by too many investors with the same strategy. At the same time, GLG has also had two of its convertible bond arbitrage vehicles come under the spotlight. GLG's market neutral fund fell 9% in May and has slumped 15% so far this year. Its credit fund fell 14.5% in May and is down 15.5% this year.
The withdrawal of money, combined with the market environment, could mean that those funds that hung on in have a chance of making higher returns. Justin Dew, senior hedge fund specialist and director with Standard & Poor's, says he has seen increasing investor interest.
"People are getting back into convertible arbitrage – we're seeing multi-strategy money getting back in, in particular. There are opportunities to be had in terms of valuation, and the environment is good in terms of equity volatility and tightening of credit spreads," says Dew. "We're also seeing institutions, which have not previously been big buyers of convertible arbitrage funds, now starting to get into that space. That's good news as it means the client base is becoming diversified so we shouldn't end up with a situation like at the end of April, beginning of May, where hedge funds' forced selling of convertibles made it ugly. It will be interesting to see if any of the multi-strategy shops of broker-dealers start launching convertible arbitrage funds now."
Julius Baer is among the fund managers taking advantage of the present environment. It is launching a hedge fund in July to trade convertible bonds and high-yield debt, and aims to return Libor plus 10% a year with an annual expected volatility of 7%.
The fund is a carve-out of existing convertible and high-yield strategies that are currently being run within the Julius Baer diversified fixed-income hedge fund, and as such will start with about $120 million in seed capital.
Tim Haywood, CIO at Julius Baer Investments, is confident that it is the right time to launch the fund. "We have got to a stage in the market which is quite appealing, and implied volatilities, as a measure of value of convertibles, are now at levels that we have not seen for a few years. Traditional convertible arbitrage has struggled as volatility has declined, but we have generated consistent value by trading global convertibles mainly against credit default swaps under-, closely or over-hedging the credit portion on a discretionary basis, leaving some equity market exposure."
In September, the fund will be open to external investors, with an initial capacity of the strategy of approximately $500 million.