Hedge funds also attribute the revival to a flood of new bond issuance from embattled companies such as Carnival and Southwest Airlines © FT montage; AP; Getty Images

One of the hedge fund industry'due south oldest — and often least loved — strategies is making a comeback, helped past this year'southward market place turmoil.

Convertible arbitrage, the strategy on which billionaire traders such as Ken Griffin and Michael Hintze cutting their teeth, is delivering healthy returns for managers once more. Hedge funds attribute the revival to a surge in marketplace volatility since the coronavirus crunch began, and a flood of new bail issuance from embattled companies such as Carnival and Southwest Airlines.

Convertible bonds let their owners to convert their holdings into a pre-determined number of the visitor'due south shares — finer a call pick on, or the right to buy, the shares. While some traditional investors just buy and hold the bonds, hedge funds buy the bonds and and so hedge their position by shorting the shares, or betting they will go down. They aim to profit from the stock'due south volatility, which increases the value of the pick embedded in the bond.

Information technology has go this yr's best-performing hedge fund strategy, gaining vi.nine per cent on average to August, co-ordinate to data group eVestment. This compares with 2.2 per cent across the broader hedge fund sector.

"Convertible arbitrage has been fantastic," said Kevin Russell, master investment officer at UBS's hedge fund unit of measurement O'Connor, which tripled its exposure to the strategy over the course of March and April.

This trading strategy "is what I grew upwardly with. It hasn't been like this for many years," he said.

Interest in convertible arbitrage wanes after credit crisis

Cedric Vuignier, head of alternative investments at SYZ Capital, increased his portfolios' exposure to the strategy by nigh ii to 3 percentage points to ten per cent this jump. "Information technology's a great strategy," he said. "This will be the best flow for [convertible arbitrage managers] since before 2008."

There is a 2d mode that the strategy benefits from large price swings. Because managers constantly accept to hedge and rehedge their positions every bit the stock price changes, they effectively terminate up buying more stock when the share price falls and selling when the cost is higher. That automatically generates a profit.

And it has been a rocky twelvemonth for stocks. Cboe's Vix index of equity volatility topped 80 in March, almost reaching the intraday high set during the 2008 financial crisis, as fears over the effects of the pandemic reached their elevation. The Vix remains above 20, much higher than boilerplate levels of recent years.

"It'south a perfect surround," said a person shut to New York-based Linden Advisors, a convertible arbitrage specialist that has gained more 12 per cent and then far in 2020.

Context Capital Direction is up well-nigh 18 per cent, meanwhile, co-ordinate to numbers sent to investors. The business firm declined to comment on its ain performance just manager Charlie Carnegie said higher volatility is helpful for such funds.

Man Group'southward GLG Global Convertibles fund is up seven.eight per cent this year. And London-based LMR suffered large losses in March'southward sell-off but has since clawed dorsum ground, helped by gains in its convertibles trading, said a person familiar with its positioning.

Issuance of convertible bonds has been a popular form of financing this year, peculiarly for companies desperately striking by coronavirus. The debt typically comes with a lower coupon than traditional bonds — meaning lower borrowing costs for the issuer — while the dilution to the equity is likely but if share prices rise much farther. Issuance this year has reached $131bn, already the nigh for a calendar yr since 2007, according to Refinitiv.

Trading convertibles can be hazardous, though, even in times of volatility. Convertible arbitrage funds lost 33.seven per cent in 2008'southward market chaos, ranking it among the hedge fund industry'due south worst-performing strategies, as traders who had been using high levels of leverage to fuel returns had to slash their positions.

Interest in the strategy has waxed and more often than not waned since and then. Since the start of 2008 investors take withdrawn more than $11bn from convertible arbitrage hedge funds, according to HFR.

Convertible arbitrage's position as a backwater for the by decade means little research coverage is now available, in some cases less than before the financial crisis. Traders say that creates opportunities for those prepared to practise their homework.

Oliver Dobbs, a convertible arbitrage veteran who worked under Sir Michael at Goldman Sachs about 30 years ago, said fewer service providers at present supply electronic copies of companies' convertible bond prospectuses than before the fiscal crunch. His Trium Credere fund is up 7.2 per cent this twelvemonth.

Options prices suggest investors expect markets to remain jumpy in the run-up to Nov'south Usa presidential election.

"The thing that makes the states coin is volatility," said Odell Lambroza, primary investment strategist at New York-based Appearance Capital, whose Global Partners fund is upward 5.1 per cent this year. "I think that's here to stay for a while."

laurence.fletcher@ft.com

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