The Arbitrage Fund (USD) gained 0.51% in November bringing the YTD return to 13.24% and the rolling annual return to 14.08%.
The November return was generated by four themes. The Mortgage Arb specialists absorbed the news that the Fed had reduced its commitment to the purchase of Government Agency issued mortgage backed debt by $25bn. In the original Quantitative Easing programme, purchases of $200bn of debt were scheduled as part of a wider initiative involving buying $1.25 trillion of Agency bonds as well but the impact of the programme is such that the last debt tranche is now considered unnecessary. So if purchases are now tapering off, is the unwinding of QE in sight? It appears not. Mortgage cost and availability has yet to normalise and remains a key issue in the Administration’s attempts to heal the housing market in the US. Newly created mortgage bonds are not flowing into the market in size and the Fed will not be a seller of mortgage paper at this stage. In this environment, our managers can build their portfolios around a core bloc of positive carry positions adding cheap optionality to enhance the returns.
The Fixed Income Arb theme was extended by the addition of a new Asian based fund which made a strong initial contribution to a positive theme performance. Their capital structure and intercompany books made the bulk of these returns. The fund only looks at fixed income securities, but ranges across the Asian region excluding Japan. Two of the remaining three managers were also solidly profitable in November.
Convertible Arb also made a strong contribution. In the US, issuance so far this year has run at an annual rate of approximately half of the 2008 level. In the spring of this year, when capital markets were just beginning to thaw, convertible issues were among the first sources of corporate funding available, and there are a number of instances where the issuers that were happy to raise money on the terms available then are having second thoughts now. So some of the issuance of that vintage is being bought back to be replaced by cheaper current sources of finance, and one of our managers generated a good portion of his return in the month from these buybacks. More generally, limited issuance combined with the retirement of existing paper creates a very positive market environment.
Instrument Arbitrage was the fourth contributor in November. ADR relationships to local markets were relatively consistent during the month, making the arb between them solidly profitable.
Multi Strat Diversified Arb represents a new theme, added to the portfolio on November 1st and initially comprising one manager. This firm concentrates on the Australian market and sets out to build a widely diversified portfolio of differing risk positions built around a core long volatility position. The satellite strategies include event opportunities, yield anomalies and convergence strategies. The market neutrality of the resulting portfolio is a primary objective of the analysis that goes into its construction.