Beat the Convertible Market

Convertible arbitrage has become a wasteland of the hedge fund landscape, yet some players have been able to beat a lousy market. Camden Asset Management, a $2.5 billion Los Angeles-based convertible arbitrage money manager, is one of them. The firm runs an $88 million hedge fund that is down 0.02% year to date. (Most sector indices have posted a negative return in the 4%-6% range.) When one considers that convertible arbitrage began to loose steam in 2003, the 4.3% three-year return of Yield Strategies Fund II (through Sept. 30) makes this fund a winner. In fact, it's the No. 3 hedge fund in this category, according to Hedge Fund Research. John Wagner, Camden's CIO, discussed the secret of his success with TheStreet.com.

TSC: How did you achieve your relatively good performance?

John Wagner: We don't view convertible trading as a commodities strategy, but as a situation where you have to take very careful consideration of each security and all of the subtle nuances. There is a way to trade convertibles where you say, 'I stuck up a model and it's cheap so I'll own it,' and I think we take into account each situation and come up with versions of how that should affect valuation.

Why has convertible arbitrage been so tough?

Because it's a short liquidity strategy: You are long the less-liquid security and short the more-liquid security. A convertible bond is always less liquid than the common stock. With the Fed loosening over the last three years, illiquidity had no premium at all. So you'd expect things to be tough. Volatility has declined for three consecutive years probably due to the looseness of credit and the looseness of the ability to borrow and the free supply of money. Defensive risk-adverse strategies have been out of favor in a world where people are able to easily borrow money. In order to get returns, people have had appetite for more and more risk. So they were sellers of convertibles, which are low-risk securities.