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Capitalizing on Rising Interest Rates and a Slow Grind Up in the S&P 500 Index

Eli Pars, CFA

  • We see an attractive opportunity set for convertible arbitrage continuing, supported by rising overnight interest rates and increased convertible issuance.
  • CIHEX and the hedged equity sleeve of CMNIX have benefited from the slow grind up in the S&P 500 Index and higher interest rates.
  • During the quarter, we reduced CMNIX’s allocation to SPACs and added incrementally to our other arbitrage strategies.

Calamos Market Neutral Income Fund (CMNIX) is designed to enhance a traditional fixed income allocation. The fund combines two complementary strategies—arbitrage and hedged equity—to pursue absolute returns and income that is not dependent on interest rates. During the second quarter, both the arbitrage and hedged equity strategies gained ground.

We actively manage allocations to the strategies based on our view of market conditions and relative opportunities. The fund’s current allocation to the arbitrage strategy is 53%, with 47% in the hedged equity strategy. At the start of the year, the fund’s allocation to the arbitrage strategy was 51%, with 49% allocated to the hedged equity strategy.

Within the arbitrage strategy, we have the flexibility to utilize different strategies, including convertible arbitrage, merger arbitrage and special purpose acquisition company (SPAC) arbitrage.* We continue to like the opportunity in convertible arbitrage most, and the fund’s allocation to this strategy grew from 39% at the start of the year to 46% on June 30. We expect to continue adding to convertible arbitrage, particularly if we see the attractive new convertible issuance that we anticipate.

We funded the increased allocation to convertible arbitrage primarily through a reduction of our SPAC book. SPACs are now 3% of CMNIX, after peaking at almost 10%. While we have sold a few SPACs, the lower allocation is primarily the result of the natural runoff of SPACs issued in 2021 with terms of two years or less.

A principal driver for our bullishness in convertible arbitrage is our heightened return expectations for the strategy on the back of the rise in overnight interest rates. Convertible arbitrage returns have historically been correlated with overnight rates. This is partly because of the direct linkage of the rebate the fund receives on its short stock positions, which is directly tied to the fed funds rate. Although returns don’t necessarily go up tick-for-tick with rates, we expect a meaningful tailwind in 2023 and beyond.

We would buy new SPACs if we saw similar terms to those we bought in 2021. Then, SPACs were profitable for the fund, with limited volatility, and our allocation served the fund well over the past few years. However, the SPAC new issue market has been quiet since late 2021. The gating factor for SPAC issuance is sponsors willing to commit capital in exchange for the opportunity to make a multiple of their investment if they can get a deal across the finish line. This tends to be a bull market trade, and we are not seeing those levels of animal spirits in the small cap space, where most “de-SPAC-ed” equities reside.

The S&P 500 Index's slow upward grind during the quarter also benefited the hedged equity side of the fund. Call volatility has come in a bit recently, but it has generally been higher this year, which has allowed us to generate more income from the options strategy while still having a significant degree of downside risk mitigation. Higher interest rates also have flowed through to the hedged equity strategy in the form of higher call prices and lower put prices, making our collar strategy more attractive. Also, a relative bid to tail risk has made put spreads an attractive tool for us to layer in extra downside risk mitigation.

Calamos Hedged Equity Fund (CIHEX) is an equity alternative designed to help investors dampen the impact of equity market volatility and drawdowns. As discussed above, the S&P 500 Index’s slow grind up in the quarter was profitable for CIHEX. In addition to benefiting from its net long exposure in a rising market, elevated call volatility allowed us to generate more income from the options strategy without sacrificing significant downside risk mitigation. Although call volatility has come in recently, we have been taking advantage of this bid to call volatility while still maintaining lighter-than-usual use of call writing. We also continue to layer in put spreads over and above our typical minimum level of notional long puts to provide additional downside risk mitigation. Finally, as noted above, higher call prices and lower put prices have made our collar strategy more attractive.

*SPACs are shell companies that raise money, which they use to acquire companies seeking to go public. The closing of the acquisition is called a de-SPAC process, at which point the SPAC is usually a small-cap equity.

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 1-866-363-9219. Read it carefully before investing.

Diversification and asset allocation do not guarantee a profit or protect against a loss. Alternative strategies entail added risks and may not be appropriate for all investors. Indexes are unmanaged, not available for direct investment and do not include fees and expenses.

Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. The views and strategies described may not be appropriate for all investors. 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.

Important Risk Information. An investment in the Fund(s) is subject to risks, and you could lose money on your investment in the Fund(s). There can be no assurance that the Fund(s) will achieve its investment objective. Your investment in the Fund(s) is not a deposit in a bank and is not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. The risks associated with an investment in the Fund(s) can increase during times of significant market volatility. The Fund(s) also has specific principal risks, which are described below. More detailed information regarding these risks can be found in the Fund’s prospectus.

The principal risks of investing in the Calamos 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.

Foreign security risk. As a result of political or economic instability in foreign countries, there can be special risks associated with investing in foreign securities, including fluctuations in currency exchange rates, increased price volatility and difficulty obtaining information. In addition, emerging markets may present additional risk due to potential for greater economic and political instability in less developed countries.

The principal risks of investing the Calamos Hedged Equity Fund include: covered call writing risk, options risk (see definition below), equity securities risk, correlation risk, mid-sized company risk, interest rate risk, credit risk, liquidity risk, portfolio turnover risk, portfolio selection risk, foreign securities risk, American depository receipts, and REITs risks.

Options Risk—the Fund’s ability to close out its position as a purchaser or seller of an over-the-counter or exchange-listed put or call option is dependent, in part, upon the liquidity of the options market. There are significant differences between the securities and options markets that could result in an imperfect correlation among these markets, causing a given transaction not to achieve its objectives. The Fund’s ability to utilize options successfully will depend on the ability of the Fund’s investment advisor to predict pertinent market movements, which cannot be assured.