Why Go Long Equities? Week ending 6-Mar

It's true, hedge fund redemptions are still going on. A total of $73bn was redeemed from hedge fund managers in Jan 2009. Given the need to meet client redemptions, highly liquid asset classes such as index futures seem to be the obvious choice for hedge fund managers.

But having witnessed the sharp falls in world equity indices in the last 2 weeks, we wonder what the impact would be on hedge fund performance. HFRX reported dismal Feb-09 results for equity strategies.

I believe this can be partially attributed to the high cost of hedging. Put option interest has been declining since Nov 08 due to higher costs - it costs approximately 25% to purchase a 12 month at-the-money put on SX5E. So implicitly it costs the same amount to buy a put as the estimated downside of the position, and if historically bear market rallies provide a 50% upside, the cost of hedging would have consumed 1/2 of the potential profits.

It would be interesting to find out the average level of protection put on by equity-based hedge funds...

Eric Tan, London

Rush to Convertibles. Week ending 11-Dec-08

Several weeks ago, I wrote about convertible bonds as an asset class that have been overlooked by investors and offer a potentially respectable stable yield in the current market environment.

Convertible bonds have been widely held by hedge funds keen to arbitrage the value of the implied option embedded in bonds, but as leverage available reduced from 5x to virtually zero, hedge funds became forced sellers and that resulted in convertible bond prices falling to all time lows.

There is now an opportunity to make relatively low-risk double digit returns without using leverage or complex hedging strategies. It is as simple as buying a distressed debt with a free option kicker on it, and in many cases, it's cheaper than the straight bond issued by the same company.

Recently, there have been pension funds, sovereign wealth funds (SWFs), and new credit opportunity and distressed bond funds being launched to invest billions of dollars into the convertible bond asset class that has become less opaque and complex with the financial market breakdown.

Eric Tan, London