Converts Cheered in Dichotomy

Chidem Kurdas

Weak economic recovery; strong financial markets. This dichotomy is likely to continue in 2013, says Larry Kantor of Barclays. Therefore the Federal Reserve and other central banks will keep rates at historic lows in an effort to stimulate economies. And investors will keep on their quest for better yield.

Convertible bonds are one of the few fixed income instruments the Barclays team sees as promising in these conditions. They point out that the supply-demand picture is robust and liquidity is better than for high-yield bonds. Convertibles provide both income and, with the option of converting to stock, risk-controlled equity returns.

Convertible arbitrage hedge funds made 7.9% year-to-date, better then average return across all strategies, according to BarclayHedge (a data provider not affiliated with Barclays bank).  Apparently they lost some return to hedging, given that unhedged convertible bonds were up 13%.

Despite promising market conditions, investors did not flock to convertible arbitrage hedge funds in 2012—assets were stagnant. To get the higher return, some investors directly bought the bonds instead of investing in funds.   .

Convertibles are very cyclical. 2011 was a losing year and there have been extended periods of losses, which resulted in an investor exodus and decimated the funds. The BarclayHedge database contains fewer funds in convert arb than in any other segment save short bias equity.

But if the convertible market remains strong, investors will likely move capital to convert arb managers, as they did in the past.

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