While relative value bond arbitrage has been out of vogue since LTCM collapsed spectacularly in 1998, threatening to take down Wall Street with it, it has delivered big returns in recent years, outpacing almost every other hedge fund strategy.
Since the beginning of 2009, the average relative value arbitrage hedge fund has returned 45 per cent, compared with 31 per cent for their regular hedge fund peers, according to Hedge Fund Research.
Italian bond markets, for example, exhibited unprecedented price discrepancies between different classes of bond issued by the government as a result of the ECB’s LTRO liquidity injection. In January, investors dumped inflation-protected Italian bonds, fearful that they would automatically drop out of key European bond indices if the country’s credit rating was downgraded, while at the same time Italian banks snapped up regular Italian bonds with LTRO cash.
Hedge funds bought the cheap inflation-protected bonds, wrote swaps to offset inflation, and then shorted expensive regular Italian bonds, thereby completely hedging out credit risk and inflation and locking in the supply and demand-driven difference between the two bonds.
Full article (FT subscription required)
© Financial Times
Key
Hover over the blue highlighted
text to view the acronym meaning
Hover
over these icons for more information
Comments:
No Comments for this Article