Interest in Fixed-Income Arbitrage Funds
Fixed-income arbitrage is a hedge fund strategy that some believe enables managers to profit in any kind of market. Fund managers identify similar securities that are undervalued or overvalued. Then they invest long in the former while shorting the latter. The goal is to profit on pricing discrepancies, or mispricing, of securities while minimizing systemic risk.
In recent years, fixed-income managers were not always able to offset poor market conditions using this strategy. According to the Barclay Fixed Income Arbitrage Index, in 2006 fixed-income arbitrage funds reported year-to-date net returns of 6.05 percent, a modest but nonetheless positive return.1 However, in 2007 these funds reported year-to-date net losses of -0.60 percent. And 2008 brought fund managers and investors crippling year-to-date net returns of -25.20 percent.
In 2009 fund managers employing this strategy reported a huge turnaround: year-to-date returns were up 19.83 percent. Although these returns did not bring investors back to par from their 2008 losses, they were encouraging and gave investors reason to be cautiously optimistic.
This year, funds are continuing to report positive returns. For the months of January and February, funds reported net returns of 2.21 percent and investors have noticed. During the past ten weeks, BHA analysts have spoken with 557 investor firms with active hedge fund mandates. Of those firms, 114, or 20 percent, have expressed interest in reviewing fixed-income arbitrage funds.
Investors are considering fixed-income arbitrage strategies because they see stability and confidence returning to financial markets, and they favor the short-term holding periods this fund structure allows. Fund managers that have experience in interest rate, corporate and government debt, and other types of fixed-income arbitrage in developed and emerging markets are sure to garner investor interest during the next several quarters.
1 BarclayHedge, Barclay Fixed Income Arbitrage Index.