March unleashes ‘perfect storm’ for arbitrage hedge funds

S&P’s Hedge fund index, a composite of fund performance, fell just over half of a percent in March, with convertible arbitrage funds suffering what Justin Dew, S&P’s Senior Hedge Fund Strategist, referred to ‘perfect storm’ of events.

Arbitrage generally refers to the ability to exploit the different prices for the same good. For that matter, convertible arbitrage funds buy and sell convertible bonds between buyers who have different valuations for the same bond. But differences in valuations of convertible bonds is typically quite small (maybe only a few basis points).

Dew attributed the sour results of convertible arbitrage funds to low market volatility, which makes sense as it would further squeeze the margins that convertible bond traders are able to find. Volatility fuels hedge fund returns, allowing them to super-size gains with each swing of the market. Without a considerable degree of market movements, this strategy just won’t yield returns that investors expect from hedge funds.

The 41 arbitrage funds that S&P tracks include tony names like Concordia, Deerfield and Gabelli among other prominent investment houses.