The Arbitrage Fund (USD) gained 0.41% in February bringing the YTD return to 0.63% and the rolling annual return to 15.46%.
Three of the larger themes in the portfolio contributed small gains in February. Their collective 70% weighting meant that these gains substantially outweighed the small loses made by the remainder.
Merger Arbitrage had a good month. Schlumberger bid for Smith, Air Products for Airgas, Merck bought Millipore, Coke bought Coke bottlers and the Xerox and Burlington Northern transactions closed. The pace of activity is rising. All three Convertible Arb managers made money, even though the environment was not particularly helpful in that credit spreads widened while volatility declined. Convertibles have become a stock pickers market once more.
Merger Arbitrage had a good month. Schlumberger bid for Smith, Air Products for Airgas, Merck bought Millipore, Coke bought Coke bottlers and the Xerox and Burlington Northern transactions closed. The pace of activity is rising. All three Convertible Arb managers made money, even though the environment was not particularly helpful in that credit spreads widened while volatility declined. Convertibles have become a stock pickers market once more.
Mortgage Arbitrage was a slight drag on the fund’s performance. As highlighted a month ago, an accounting change led two of the US Governments Mortgage Agencies to accelerate their buy out of damaged loans. Because of their high coupons, the bonds called in this process were typically trading above par, so unwary holders took a knock on the news. In addition to the direct losses, this created some dislocation, risk aversion and spread widening in certain mortgage bonds, which temporarily exaggerated the direct effect. A part, in fact the larger part, of the QE programme was executed by means of Fed purchases of mortgage bonds. This buying will formally end on March 31st although there is no indication that the Fed will sell any of its holdings in the foreseeable future: the exertion of downward pressure on mortgage costs remains a key policy goal. Obligingly, markets are pricing overall Agency Mortgage Bond spreads at historic lows.
We have redeemed our sole Multi-Strat Diversified Arbitrage manager. We remain convinced of his skills, but his fund lost a dominant client, raising its expense ratio above the threshold of acceptability.
In February, we added one manager to seed a Volatility Arbitrage theme with an initial 2% weighting. The environment in which Arb specialists operate continues to be benign. But the co-ordinated reflation policies brought to bear on the 2008/9 crisis are now generating uncoordinated recoveries with highly differentiated asset market consequences. The resulting pressures on sovereign credit, interest rates, foreign exchange and equity markets will throw up anomalies not just in the prices of these assets, but in the markets that trade the volatility of those prices as well.