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AQR Capital praises convertible arbitrage revival amid high-rate environment

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Cliff Asness’s AQR Capital Management has touted the resurgence of convertible arbitrage, a niche strategy that capitalises on debt convertible into equity, according to a report by Bloomberg. 

The strategy has now surpassed merger arbitrage as the largest exposure in AQR’s $1.9bn Diversified Arbitrage Fund. Convertible arbitrage positions comprised around 45% of the fund’s net assets in Q1 2024, up from about 33% in June 2023. AQR’s Diversified Arbitrage Fund has returned 0.5% year-to-date and 4.1% over the past year. 

The $109bn quant firm, based in Greenwich, Connecticut, anticipates that convertible arbitrage will gain momentum due to increased new issuance in a high-interest-rate environment.  

Hedge funds have been channeling more capital into this strategy as companies increasingly issue convertible bonds, which are generally cheaper than conventional debt. AQR highlights the increased opportunities due to a variety of corporate events and a significant volume of maturing convertible bonds. 

Josh Lavan, managing director of convertible bond strategies for AQR Arbitrage, said: “It’s really the expansion of the opportunity set that gives us the reason to keep adding exposure. 

“We saw almost $20bn in convertible bond issuance in May alone, and June has started off strong.” 

The strategy’s appeal is further boosted by convertible bonds issued at low yields during the pandemic, which are now nearing maturity. This often results in companies repurchasing their debt at a premium or offering favourable terms in new issues, creating entry points for arbitrageurs. Bloomberg’s data indicates that US convertible bonds worth about $115bn are set to mature between now and 2026. 

This revival marks a significant turnaround from the financial crisis era when convertible arbitrage suffered massive losses. According to a paper by the CFA Institute, the strategy incurred losses of 34% in 2008 due to market financing being withdrawn. 

Last month, Bloomberg reported that Man Group, the world’s largest listed hedge fund, was among a number of investment firms increasing their exposure to convertible arbitrage. 

Overall, Nasdaq eVestment data reveals that convertible arbitrage strategies attracted over $700m in inflows through April, while event-driven funds saw outflows exceeding $8bn. The Bloomberg Convertible Bond Arbitrage Index rose by 5.33% during this period, while the Merger Arbitrage Index declined by 0.12%. 

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