Who would have thought a year ago, in the immediate aftermath of the credit crunch, that there would now be such a large number of UCITS hedge funds, encompassing almost the full range of investment strategies. There are not only relatively simple long/short equity funds but also an increasing number of more complex macro, arbitrage and commodity vehicles.
As part of alternative investment ideas, volatility trading strategies could be filed under the existing category of “volatility arbitrage” and “relative value arbitrage”.
Options are often viewed as complex financial instruments on the capital markets, so the opportunities of volatility as a source of investment returns are often overlooked. Implemented by an experienced derivatives trader, volatility-orientated trading strategies often have a stabilising effect on an investor’s portfolio because of their correlation to classic long-only bond investments, for example, bonds, shares and property. They reduce the risk and often act as an insurance against external shocks.
Ever since the stock markets have come in existence, arbitrage has always been present. Though, through natural evolution, one form of arbitrage may disappear but others take its place. In this article, I focus on equity arbitrage strategies that we deploy actively. We will not do justice, if we did not discuss the risks that go with equity arbitrage, so each strategy has inherent risks that are also addressed.
In the past few years the hedge fund market has grown in a spectacular manner, with total assets surpassing US$1 trillion in the first half of 2005. This growth has been aided by the lacklustre returns on the equity markets since the burst of the dotcom bubble in 2000 and by a benign climate for many hedge fund strategies, resulting in double digit annual returns for many hedge funds. However, with the strong increase in hedge fund assets, in combination with a changed market environment, it has become more difficult to make the same returns in many hedge fund strategies. In relative value arbitrage strategies in particular, more money seems to be chasing a smaller set of opportunities, resulting in lower or even negative returns.
New research being carried out jointly at Dublin City University Business School and University College Cork provides important findings for those considering an investment in convertible bond arbitrage. Evidence is provided that in severe market downturns convertible arbitrage exhibits negative returns. This negative return is due to increases in credit spreads. Evidence is also found that in severe market upturns the daily returns from a convertible bond arbitrage portfolio are negatively related to equities. In effect the returns to convertible bond arbitrage are akin to writing naked out of the money put and call options.
Lynx Arbitrage is an Asia Pacific, relative value volatility arbitrage fund with a stated focus of delivering optimal, consistent "risk-adjusted" investment returns uncorrelated to general market movements and trends by exploiting pricing anomalies between Asian Pacific stocks and related exchange traded derivative contracts.
The goal of convertible bond arbitrage is to consistently make money regardless of market conditions and to do so with minimal volatility. The basic mechanics of this market neutral approach is to take simultaneous long and short positions in a convertible bond and its underlying stock. By having the appropriate hedge between long and short positions, the arbitrageur hopes to profit whether the market goes up or down. Despite a focus on absolute returns rather than beating market indices, convertible bond arbitrage strategies have outdone the S&P 500 index with significantly lower volatility over the past decade.
Albert Saporta is AIM&R's founding partner and has 17 years' experience in global financial markets. The Firm has a team of 5 professionals with offices in Geneva and San Francisco. Before starting AIM&R, Mr. Saporta worked for IFM, UBS Securities, Merrill Lynch and Paribas. He currently runs two hedge funds, the SOG Fund (global multi-strategy arbitrage) and SOGAsia. The SOGAsia fund is an Asia including Japan, multi-strategy arbitrage fund. It employs structure arbitrage, closed-end fund arbitrage, pair trading, merger arbitrage and event driven strategies. The SOGAsia Fund was launched in July 2002 and was +1.4% for 2002. Mr. Saporta is based in Geneva.
The following article is written by Mike Roth, a founding partner of Stark Investments, as a response to an article on Convertible Bond Arbitrage appearing in Eurekahedge's October monthly issue. Stark Investments specialises in global multi-strategy arbitrage and is the manager of the Stark Japan Fund.
Diggle has over 16 years of experience in trading equities and equity derivatives in both Asia and Europe. He was formerly Head of Asian Equity Derivative Trading as well as former Head of European Emerging Markets at Lehman.
The Artradis Barracuda fund is an Asian equity arbitrage fund. It employs multi-strategy market neutral trades such as warrant arbitrage, index arbitrage, stock class arbitrage, convertible bond arbitrage, volatility arbitrage, volatility dispersion and dividend arbitrage.