Bond Market Worries Favor Arbitrage

Chidem Kurdas

Rates are so low, the only direction they can go is up. That’s the conventional wisdom and it implies that the bond rally is near its end.  Despite that concern, investors have been moving money to fixed income arbitrage funds. The reason is that these funds, unlike long-only bond investments,  typically do not bet on market direction.  Hence rising rates are not likely to squash their return.

In 2011 fixed income arbitrage made 4.7%, as measured  by the Dow Jones Credit Suisse Broad Index. While that looks puny compared to the 7.8% return on Barclays Aggregate Bond Index, arbitrage is not as vulnerable to market shifts compared to long-only bonds.

In any event, most investors are not buying an index; they’re buying specific managers. Within the fixed income arbitrage field are funds that did much better than the group.

One that I noticed is Cranwood Fixed Income Arbitrage Fund, up 17.7% for the year. Cranwood’s strategy is to identify short-term discrepancies on the US Treasury yield curve and use futures contracts for Treasury notes and bonds to trade on the spreads. Cumulative return since inception in 2008 is over 62%.

Hedge funds as a whole lost money in 2011. Fixed income arbitrage was one of the best performing strategies. It has not been a popular strategy in the past but received inflows of $18 billion in the past 12 months according to Barclay Hedge.


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