Hedge Funds Ramp Up Convertible Arbitrage Strategy Amid Market Opportunities

Man Group, the largest publicly traded hedge fund globally, is among a growing number of investment firms increasing their exposure to convertible arbitrage, a strategy that exploits price discrepancies between convertible bonds and their underlying stocks, according to Bloomberg.

Data from Nasdaq eVestment reveals that convertible arbitrage strategies saw significant inflows in the first quarter of 2024, while other hedge fund strategies experienced substantial outflows. The strategy, which involves buying convertible bonds and shorting the corresponding stock, delivered an average return of 4.4% over the first four months of the year, outperforming many other relative value approaches, as reported by Hedge Fund Research.

Convertible arbitrage profits arise when the stock price moves favourably. If the stock price declines, investors benefit from the short position, while if the stock appreciates, the bond can be converted into equity. However, the strategy can suffer if refinancing issues lead to a sharp drop in bond prices.

The convertible bond market is set to receive further attention, with more than $200bn of bonds maturing in the next five years. Lower interest rates and high stock valuations are drawing firms to refinance. Adam Singleton, CIO of Man Group’s external alpha team, confirmed that the firm is increasing its stake in this market.

Linden Advisors, a US-based hedge fund specialising in convertible arbitrage, reported a 5.8% return in the first four months of 2024 after a 12% gain in 2023. Context Partners, managing around $1.7bn, also posted impressive returns, up by over 6% as of May 10.