Watch: CMNIX’s Pars on Convertible Arbitrage
December 21, 2017
Convertible arbitrage is one of the strategies used in the management of Calamos Market Neutral Income Fund (CMNIX), a 27-year-old fixed income alternative fund that is the largest in its Morningstar Market Neutral category (as of 9/30/17). Covered call writing is the other core strategy. CMNIX takes advantage of the two strategies’ different responses to volatility to enhance the fund’s potential for risk-managed returns.
We recently published a Convertible Arbitrage 101 explainer. In addition, our Ask the Portfolio Manager series asked Eli Pars, Co-CIO, Head of Alternative Strategies and Co-Head of Convertible Strategies, Senior Co-Portfolio Manager, to elaborate on how the strategy is used, the current environment for convert arb and why it’s a particular strength of Calamos. Calamos is the eighth largest liquid alternative manager by assets under management, according to Morningstar data as of 9/30/17 (see Our Alternatives Work post).
Pars describes convertible arbitrage as “an old school hedge fund strategy” that tries to earn a return no matter what the market environment is (see No Matter What: CMNIX).
“You're buying a convertible bond and you're shorting the company stock against it to try to create an equal return whether the stock goes up or the stock goes down,” he says.
At roughly $300 billion, the global convertible market is “plenty big for us to do a lot in and find a lot of opportunities but small enough that it's still kind of a niche strategy,” says Pars.
The long equity bull market has presented opportunities for the convertible arbitrage investor to buy puts at discounts to their normal intrinsic value, Pars says.
Convertible arbitrage has performed well in most equity market environments but has historically done its best in declining markets, according to Pars.
“If you’re in the camp that thinks we’re in an overvalued equity market that ultimately corrects similar to what we had in the early 2000s, that could quite possibly be a very nice environment for convert arb,” he says.
As Pars explains in this video, convertible arbitrage has the potential to generate income from four sources:
- Income from coupons on convertible bonds
- Short interest credit from short stock positions
- Capital appreciation from undervalued securities
- Rebalancing/trading—gamma capture (for a detailed explanation, see this post and this video)
Convertibles are in Calamos’ DNA, Pars says, explaining that John Calamos was doing convertible arb strategies even before he started Calamos Investments. Convertible arb has been pursued in mutual fund form since 1990, he says and provides some information on the background of CMNIX’s two co-portfolio managers, Jason Hill and David O'Donohue.
“While we've diversified into other strategies, a lot of our research is still geared toward some of the things we learned. First, with convertibles, our approach to capital structure research. We look at the whole cap structure…When you're looking at convertibles, you have to understand the credit, the equity and the convertible and how they interplay,” Pars says.
Financial advisors, for more information about how convertible arbitrage is used in CMNIX, talk to a Calamos Investment Consultant at 888-571-2567 or email firstname.lastname@example.org.
Before investing carefully consider the fund’s investment objectives, risks, charges and expenses. Please see the prospectus and summary prospectus containing this and other information which can be obtained by calling 1-800-582-6959. Read it carefully before investing.
Videos recorded 11/30/17.
Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. The opinions and views of third parties do not represent the opinions or views of Calamos Investments LLC. Opinions are subject to change due to changes in the market, economic conditions or changes in the legal and/or regulatory environment and may not necessarily come to pass. This information is provided for informational purposes only and should not be considered tax, legal, or investment advice. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations.
Alternative investments are not suitable for all investors.
The principal risks of investing in the Market Neutral Income Fund include: equity securities risk consisting of market prices declining in general, convertible securities risk consisting of the potential for a decline in value during periods of rising interest rates and the risk of the borrower to miss payments, synthetic convertible instruments risk, convertible hedging risk, covered call writing risk, options risk, short sale risk, interest rate risk, credit risk, high yield risk, liquidity risk, portfolio selection risk, and portfolio turnover risk.
Covered Call Writing: As the writer of a covered call option on a security, the fund foregoes, during the option’s life, the opportunity to profit from increases in the market value of the security, covering the call option above the sum of the premium and the exercise price of the call.
Convertible Securities Risk: The value of a convertible security is influenced by changes in interest rates, with investment value declining as interest rates increase and increasing as interest rates decline. The credit standing of the issuer and other factors also, may have an effect on the convertible security’s investment value.
Convertible Arbitrage Risk: If the market price of the underlying common stock increases above the conversion price on a convertible security, the price of the convertible security will increase. The fund’s increased liability on any outstanding short position would, in whole or in part, reduce this gain.
Data as of 9/30/17
Performance data quoted represents past performance, which is no guarantee of future results. Current performance may be lower or higher than the performance quoted. The principal value and return of an investment will fluctuate so that your shares, when redeemed, may be worth more or less than their original cost. Performance reflected at NAV does not include the Fund’s maximum front-end sales load of 2.25%. Had it been included, the Fund’s return would have been lower. For the most recent month-end fund performance information visit www.calamos.com.
Citigroup 30-Day T-Bill Index is generally considered representative of the performance of short-term money market instruments. Morningstar Market Neutral Category represent funds that attempt to eliminate the risks of the market by holding 50% of assets in long positions in stocks and 50% of assets in short positions.
Bloomberg Barclays U.S. Government/Credit Index comprises long-term government and investment grade corporate debt securities and is generally considered representative of the performance of the broad U.S. bond market. Unlike convertible bonds, U.S. Treasury bills are backed by the full faith and credit of the U.S. government and offer a guarantee as to the timely repayment of principal and interest.
Morningstar Market Neutral Category represent funds that attempt to eliminate the risks of the market by holding 50% of assets in long positions in stocks and 50% of assets in short positions.