odin

Thoughts on Portfolio Construction and Diversification (Part 2)

>
> In regards to converts, its my understanding that, as you pointed
> out, a lot of hedge funds were in the convert arb strategy, and the
> ban on short selling effectively blew that strategy up, resulting
> in wide scale "dumping" of convertible bonds, killing the NAVs of
> convert funds. Still, the sector HAS recovered, somewhat, this year.
>

Agreed. The asset class has rallied along with/due to credit. However, it bears noting that returns here are driven by technicals just as much as fundamentals. And a lot of funds that are underwater massively are less incentivized to keep going. I shudder to think of the impact if one of the big billion+ funds decided there just wasnt enough opportunity left to keep going. For what its worth, I do like the asset class (the hybrid nature allows you to stay in the sweet spot of changing sentiments much longer) but for profitable convert investing, timing is very much key.


> A final point in regards to steep discounts to NAV, something I've
> noticed is that there's a growing tendency by CEFs to periodically
> (like once a year) announce a tender for a certain percentage of
> shares outstanding, typically, at a price somewhere around 3-5% under
> NAV. Since quite a few funds trade at discounts north of 10%, that
> can result in a pleasant "surprise" for fund holders.

True, but that would not be the basis for my trade. There are faster guns trading on that kind of information.

Thoughts on Portfolio Construction and Diversification (Part 2)

While I do believe that yield is going to be valuable in the future, not all income funds are born equal (on a risk-adjusted basis). It is important to realize that with fixed income investing that you are selling a put on the assets. GIM for e.g. has a high yield because its invested heavily in the sovereign debt of emerging markets (Russia, South Korea, Australia etc). Unsurprisingly, they are heavily correlated to those markets. I'm not sure that they will provide the safety that people expect out of fixed income investments. Similarly, HTR is a leveraged fund and that point bears attention.

As a guide, it is likely that the historical default rates on HY instruments will understate the future defaults by a wide margin.

Valuation is simply one aspect of convertible bond trading. Because the market is not extremely deep (comparatively speaking), technicals play a huge role. That is what took down converts last year and I dont believe looking at charts can give a sense of how institutions are looking at convert funds (or when a big fund winds down). Convert arb is still dead and a lot of funds are way under their high water marks.

While buying CEFs at a discount may psychologically feel better (good value), there are many reasons why CEFs trade at discount/premiums. Those discounts are not realizable unless a fund liquidates and if it does liquidate, its likely doing so under distressed conditions. The middle-single or even teen digit discounts will be little consolation. What is more important to see them in the context of historical discounts.

I think CEF/ETF investing for individuals has many positives, but the above points need attention.