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Hedge funds get convertibles break
Convertible bonds the worst performing hedge fund strategy this year, but recovery underway.
July 8, 2005: 12:35 PM EDT
By Amanda Cantrell, CNN/Money staff writer

NEW YORK (CNN/Money) - Hedge funds that follow the much-beleaguered convertible bond arbitrage strategy finally got a break in June, posting positive monthly returns for the first time this year, according to new research.

The slump in convertible bonds that has felled three big hedge funds this year began to end in mid-May and throughout June, according to research from Goldman Sachs. Its U.S. Convertible Hedge Fund Index recorded a preliminary gain of 1 percent in June.

For the first half of the year, the index is down 7.7 percent.

Convertible arbitrage managers buy convertible bonds, which are bonds that can be exchanged for a certain amount of a company's common stock, and short the underlying stock of the issuing company to profit from the difference in price between the two securities. It has historically been a safe, conservative strategy, with consistent returns and low losses.

But it is the worst performing hedge fund strategy this year, and the plunge caused some large convertible arbitrage hedge funds to close. These include San Francisco-based Marin Capital Partners, which had $2.2 billion in assets at its peak, and Alta Partners, run by San Francisco-based Creedon Keller & Partners, which had about $1.2 billion at its peak.

Most recently, EBF & Associates shuttered its $669 million Lakeshore International Fund, according to a report in the Wall Street Journal.

The rout began late last year, when investors in these hedge funds, unimpressed with a streak of lackluster returns, began asking for their money back. The redemption requests forced managers to sell into a market with no buyers, which drove returns even lower.

According to Goldman's research, market sentiment on convertibles is still mixed, but valuations for these bonds are getting higher. People in the industry say that hedge fund managers are now the majority of buyers of convertible bonds, also contributing to the problems.

Some managers and investors think that the drop in valuations mean it's an attractive time to buy convertibles, which will signal a comeback for the strategy. But others think that the marketplace is too crowded and the strategy could eventually die out.

The managers in the Goldman convertible arbitrage index have lost 23 percent of their capital since the start of the year due to investor redemptions.

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