From the December 2006 issue of Investment Advisor • Subscribe!

December 1, 2006

Convert Arb Makes a Comeback

A survey of 15 organizations with around $117 billion of assets invested in hedge funds revealed a huge decline in the popularity of global macro strategies quarter-on-quarter. In the latest edition of the Hedge Fund Strategy Barometer, not only did fewer survey respondents express an interest in the strategy, but the number of investors ranking global macro as their preferred strategy plummeted to 9% from a reading of 21% just three months ago.

Survey respondents included some of Europe's most important hedge fund investors. Cyril Delamare, managing director of Tara Capital, attributed the dramatic shift to the poor relative performance put up by global macro managers over the past year. In a turnaround that typifies how strategies can come into and fall out of favor, 53% of respondents said they would be increasing allocations to convertible arbitrage next year, while only 7% said allocations would be reduced. Delamare said that this was the strategy's best showing since the Barometer first appeared three years ago.

Convertible arbitrage managers, last year's punching bags, have turned in good performance in 2006 and in the third quarter they saw $2.29 billion in new assets, the second-straight quarter of net inflows. In the third quarter of 2005, $725 million in assets left the strategy. Whether the renewed interest in convertible arbitrage turns out to be a reward for the managers or punishment for investors remains to be seen. One argument for convertible arbitrage's good performance this year might be that there were fewer dollars in the strategy owing to last year's poor performance, making it easier to find winning bets. Bulging assets in arbitrage strategies tend to squeeze returns.

Among relative value strategies, equity market neutral was also popular, with 40% of respondents saying they would increase allocations to the strategy, against 7% who aimed to reduce exposure. Twenty percent of respondents said they would increase global macro (both discretionary and systematic) allocations, with 13% looking to remove some money from the table.

Notwithstanding the continuing rally in world stock market indexes, the popularity of long/short strategies continues to fall, with only 20% of respondents identifying this as their preferred investment idea, down from 41% in the previous quarter and 56% at the end of 2005.

For global long/short, 13% said they would increase their exposure, while 20% were looking to reduce it. But 40% of investors want to increase long/short Japan allocations, with just 7% reducing. For Europe and Latin America, 33% want to increase, with 13% and 7%, respectively, saying they would reduce positions. And 20% look to raise long/short exposure to Asia, while no one said they would reduce allocations to that market.

The most popular "new" alternative was asset-backed lending, where 40% of investors said they would seek to raise exposure. In this group, energy trading seems to have the least traction at present: 13% of respondents said they would be increasing allocations, while 27% were looking to reduce their positions.

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