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Convertible arbitrage managers outperform

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The month of May was characterised by negative returns in stock markets, while volatility rose significantly, albeit remaining low compared to historical levels. The bond market continued its downward trend driven by higher interest rates, and volatility remained fairly stable. Commodity prices levelled off in May after the recent increases. All strategies showed either negative or positive-but-very-low returns, except the Convertible Arbitrage strategy with a return of 0.91%.
Indeed, convertible arbitrage managers continued to improve their performance and to benefit from higher T-Bill rates, despite the considerable increase in credit spreads.
The worst negative returns come from the Long/Short Equity strategy with -2.43%, which shows a correlation of more than 70% with the S&P 500 index. The underperformance of this strategy could be explained by the poor performance of the stock markets, the increase in implied volatility, and a higher credit spread.
CTA Global also posted a highly negative return with -1.48%, which could be explained by the recent developments in the commodity markets and bond markets. While bond returns largely contributed to the underperformance of CTAs, the volatility of bond returns remained stable at a very low level.
The falling returns of the three equity-oriented strategies (Equity Market Neutral, Event Driven and Long/ Short Equity) during the month of May were easy to link to the underperformance of the stock markets.
Despite the low level of volatility, the large increase in implied volatility is an additional factor behind the underperformance of the three strategies. Two other factors may have contributed to the lower returns: small versus large cap and changes in credit spreads. The three strategies are positively correlated to the former and negatively correlated to the latter.
As the three strategies are exposed
to small caps and the differential between large and small caps widened in May, hedge fund managers in the three strategies were highly exposed. Correlations with changes in credit spreads are negative and high.
Hence, it was easy to relate the underperformance of the three strategies to the considerable increase in credit spreads.
Mathieu Vaissié is research engineer with the Edhec Risk and Asset Management Research Centre

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