Ireland
| A convertible bond is a like a regular fixed income bond that typically pays interest coupons, though usually at lower rates. However, it differs from a straight bond because it can be converted into a pre-specified number of equity shares at a predetermined share price. It acts like a regular bond with an embedded call option on the company stock. In that respect, convertibles are not a mainstream asset class and are typically viewed as niche and complex. However, the market has grown substantially in recent years. This expanded investment universe is presenting new opportunities for investors with the relevant skillset and experience to generate alpha. |
How convertible arbitrage works
A convertible arbitrage strategy aims to generate returns by holding a long position in a convertible bond alongside a short position (hedge) in the underlying equity. As the pricing of the bond and underlying equity change, the relationship between the two can be expected to shift, leading to the potential for skilled investors to generate a return.
Insight’s convertible arbitrage strategy
Insight’s convertible arbitrage strategy aims to deliver positive returns while offering low correlation with mainstream assets and emphasising capital protection. It considers four key components of convertible bond returns: movements in equity prices, volatility, credit factors and interest rates. Our strategy aims to generate returns primarily from market inefficiencies in the pricing of the equity and volatility components. Through volatility capture, we aim to generate returns from the change in dynamics between price moves in the convertible bond and the underlying equity. Equity themes are another focus element, where positions generate returns from equity upside, which we expect to lead to positive convertible bond performance, in specific sectors and areas of the market.
Why now for convertible arbitrage
We believe a convertible arbitrage strategy can play a meaningful role in investor portfolios today for several reasons.
- Improves diversification – Convertible arbitrage strategies typically exhibit low beta and low correlations to other asset classes.
- Access new opportunities – We believe an expanded universe and opportunity set should provide an increase in opportunities for convertible arbitrage strategies to potentially generate returns going forward.
- The impact of volatility – Convertible arbitrage strategies, with their potential to capture gains from volatility, can actively benefit from such episodes by aiming to exploit the relative changes in pricing of a convertible bond versus its underlying equity.
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