According to Greenwich, European investors use credit default swaps more extensively than US investors, with 22% of portfolios placed under credit default protection compared with just 8% in the US. Convertible arbitrage hedge funds buy convertible securities, hedge the bonds and sell the underpriced embedded options, capturing any mispricing error. Many then use credit default swaps to hedge the credit risk.
“European institutions also invest less in busted or distressed convertibles, which shows the greater degree of caution with which Europeans are embracing this market,” said Greenwich Associates consultant, Jay Bennett.
The study also found that hedge funds specialising in convertible arbitrage value liquidity as the most important selection criteria for brokers. “Roughly half the institutions investing in convertibles are hedge funds who contribute the lion’s share of the trading volume," said Greenwich Associates consultant John Fe. "They often trade on short-term investment ideas and want volume with quick turnaround. All of that points to the value of liquidity."
Jeremy Howard, head of US convertibles research at Deutsche Banc Alex. Brown in New York told RiskNews: “This is really a reflection of the US market. There is much less convertible issuance on investment grade names, so hedge funds and outright investors are buying up below-investment grade or distressed names, and it’s much harder to buy credit protection on these names.”
Howard added that investors are getting used to the lower credit quality by doing their own internal research and taking a credit view.
The week on Risk.net, July 7-13, 2018Receive this by email