Analysing the performance of Convertible Arbitrage Funds, Credit Suisse faced with the worst results in the Credit Suisse/Tremont Hedge Fund Index (“Broad Index”). Cumulative returns have come down from over 100% to 40% (a level not seen since September of 2002) and annualized returns have dropped to 4% over the same period.
All funds are in negative territory as Convertible Arbitrage managers have seen six years of performance wiped out in less than six months. Convertible Arbitrage managers began the year on a high note– the sector had generated cumulative returns of over 100% between January of 2000 and January of 2008, while annualized returns over the same period were close to double digits.
Many funds couldn’t retain strong position due to recent market volatility lead to the considerable dispersion of performance. Monthly returns for the sector have ranged from 1.5% to -12.3% in 2008; however, the difference between the top and bottom returns of individual managers has been more pronounced. Five funds in the index have seen monthly return differences of greater than 25% between January and October of this year, while only two of the funds in the space have experienced differences of less than 10% between their best and worst month.
Assets under management in the Credit Suisse/Tremont hedge fund comprise approximately $24 billion and 2% of the Credit Suisse/Tremont Broad Index. . It is estimated that approximately one third of funds within the Convertible Arbitrage sector of the Broad Index have currently imposed gate provisions, suspended net asset value calculations or have been otherwise impaired by the adverse market conditions. However, as has occurred after past incidences of market turmoil, the dislocation in the sector may also lead to future opportunities.
The effective “wiping out” of Fannie and Freddie convertible preferred shares that occurred after their nationalization, combined with the direct and indirect losses stemming from Lehman issued shares, resulted in severe de-valuations of convertible securities. These events of the past two months along with the bankruptcy of Lehman Brothers and the implementation of short sale bans contributed much to the substantial loss in the space.
Historically, periods of significant hedge fund redemptions have in many cases been followed by periods of significant returns.
Some Convertible Arbitrage managers in the Credit Suisse/Tremont Hedge Fund Index have expressed plans to launch new funds to take advantage of current opportunities. New players such as pension funds, insurance companies and certain hedge funds, particularly Multi-Strategy managers who have stayed on the sidelines with dry powder to invest, appear to be entering the space, providing hope that the added liquidity and diversification will help stabilize the markets and funds will be in a position to profit from the unique investment opportunities that have been created. Most managers believe that the current valuations of convertibles are attractive and those managers who survive this downturn will likely stand to profit.
L.D.