Lyxor says M&A hedge funds to shine

Date: Friday, November 23, 2007
Author: Peter Starck, Reuters

FRANKFURT (Reuters) - Hedge funds focused on arbitrage between convertible bonds and the underlying stocks could outperform next year amid widening credit spreads and continued high volatility, Lyxor Asset Management said.

Another strategy Lyxor expects to do well in 2008 is "event-driven" where hedge funds pounce on stocks in companies involved in merger and acquisition (M&A) activity, Lyxor said on Wednesday.

Lyxor, part of French bank Societe Generale (SOGN.PA: Quote, Profile , Research), has 72.8 billion euros (52.3 billion pounds) in assets under management of which 25.8 billion euros are in hedge funds.

"Higher volatility and lower correlation between asset classes will favour arbitrage hedge funds," Mathias Ranke, head of Lyxor in Germany, told a news conference.

Despite widening this year, credit spreads -- the difference between yields on corporate and government bonds -- remains moderate by historical standards, suggesting that "risk premiums are not fully discounted," Ranke said.

He saw opportunities for convertible arbitrage, a strategy where hedge fund managers try to generate returns by trading mis-matches in prices between a convertible bond and its underlying equity.

Overall, stock market valuations remained low and that would lead to "a lot of events, renewed M&A activity next year," Ranke said, adding that the year-to-date return on Lyxor's event-driven hedge fund at 19 percent was more than double that of the MSCI World benchmark equities index.

Measured by hedge fund researcher HFRX's index of hedge fund performance, the asset class has held up better than equities in the recent months of uncertainty sparked by the credit crisis, rising oil prices, a weaker dollar and worries about the outlook for U.S. economic growth, Ranke said.

In such a difficult market environment, "timing is key," he said. Lyxor's hedge funds want to avoid a "long bias", or investments based on expectations of rising asset prices.

Further key rate cuts by the U.S. Federal Reserve could, however, support stock markets, Ranke said.