Convertible arbitrage top hedge strategy

Date: Wednesday, January 17, 2007
Author: Keith Damsell, Mutual Funds Reporter, Globeandmail.com

Returned 15.2% in 2006, RBC says.

KEITH DAMSELL
MUTUAL FUNDS REPORTER

Convertible arbitrage was the hedge fund strategy of choice in 2006.

The complex investment strategy returned an average of 15.2 per cent last year, reported RBC Dominion Securities Inc. yesterday. The gain beats the average hedge fund return of about 10.6 per cent in 2006, the investment dealer said. In 2005, the hedge fund sector returned about 7.5 per cent.

Convertible arbitrage -- the simultaneous purchase of a portfolio of convertible bonds, while selling short the corresponding equity shares -- was a strategy out of favour and cheaply priced early in 2006, said Winson Ho, co-head of the RBC Alternative Assets Group.

But a U.S. equity rally in the last six months of the year meant a significant "snap back" in fortunes for oversold convertible arbitrage managers, he said.

"Convertibles benefited from stronger equity prices and from tighter credit spreads," Mr. Ho said. "What you saw last year was credit spreads got tighter and equity prices got higher."

The hedge fund results are derived from the RBC Hedge 250 Index, an 18-month-old investable benchmark that tracks the performance of some of the world's largest hedge funds. The index of 250 funds is based on a universe of more than 5,600 hedge funds with more than $1.1-trillion (U.S.) in assets under management.

Equity long-short hedge funds had a strong year too, returning 13.6 per cent. Long-short investing, the most popular hedge fund strategy in Canada, generally reflects equity market returns, said Wilson Tseng, an analyst at Canadian Hedge Watch Inc. in Toronto. The S&P/TSX composite index gained about 14.5 per cent in value in 2006.

Hedge fund managers who use macro strategies were the year's weakest performers, returning a slender 1.4 per cent. Macro managers -- a trading strategy in global currency, interest rate, equity and commodity markets -- had a "tough time" finding an investment theme in 2006, Mr. Ho said.