The Arbitrage Fund (USD) gained 1.32% in December bringing the YTD return to 14.74%.
For December, all but one of the managers in the portfolio turned in positive results, generating profits in all themes and the fourteenth consecutive monthly gain for the Fund. In the year 2009 as a whole, all themes were profitable. Convertible Arbitrage and Mortgage Arbitrage contributed just over two thirds of the return. However, this should not obscure the fact that, together, the remaining four themes, contributed in excess of the Funds stated target return of LIBOR +300bp.
In the month, four themes contributed the bulk of the gains.
Merger Arbitrage made money in the month. Spreads have tightened during the year. This partly reflects the fact that, we did not see the wave of transactions predicted by the intermediaries. Lawyers and Investment Bankers see preparatory work well ahead of public merger announcements. Highly unscientific feedback from this community suggests considerable ongoing activity, which bodes well for 2010. So does the strength of corporate balance sheets overall. The Companies that make up the S&P index have doubled their net cash reserves to $1.5 t in the past 4 years. Of course they can make acquisitions with their own stock, but historically, large cash reserves tend to embolden potential acquirers.
Measures of volatility continued to decline in December with the Vix for example, now below its 10 year average. Convertible Arbitrage was profitable despite this headwind. New issuance in the US finished the year at $40bn, the lowest total in the past 10 years. In Asia, Japanese Companies were the largest issuers of CB’s. The level of new equity issuance in Asia in 2009 (60 IPO’s in HK) lays the foundation for an increase in the population of potential issuers in the year ahead. 2010 will not be a rerun of the exceptional return achieved last year. But the fact that the sector has not been flooded with paper, and valuations that have stabilised at levels that are still cheap to theoretical values, offers investors the prospect of a constructive start to 2010.
All four managers in Fixed Income Arbitrage were profitable in a month that saw US Treasury yields increase from 0.67% to 1.14% in the two year note and 3.21% to 3.85% in the 10 year. Towards the end of the year, liquidity diminished faster than the new supply of bonds, so the US Treasury had to provide increasing incentives to the Arb community to induce the level of support they needed the market to provide.
Our Mortgage Arbitrage managers captured the spread on their portfolios and made money from their interest rate hedges as well.
The Instrument Arbitrage manager finished off a strong year with a positive month. He saw opportunities in ADR arbitrage as the Tokyo market turned positive in tone and made money in dual listed stocks. The persistence of interesting spreads in these activities is a barometer of capital allocated to the field of arbitrage. When the Investment Banks have money to use for this type of proprietary trading, these spreads come under pressure. Happily, they are still at equivalent levels to those seen a year ago.