One of the winners of the recent retail-driven US stock market boom is investors in the niche market of convertible bonds, which allow investors to convert bonds into stocks when a company's share price reaches a certain price.
While Silver Lake, a private equity firm, took advantage of the sharp rise in AMC Entertainment, the bonds of other companies also rose. AMC Entertainment is one of the central stocks of the retail investment frenzy.
The price of convertible bonds held by Ligand pharmaceuticals has risen by 10 per cent since January 25th. Meanwhile, American airlines' convertible bonds rose 9%, an all-time high. Both stocks were driven higher by retail buying.
"that's why you buy convertible bonds," said Geoff Dancey, a portfolio manager at Cutler Capital Management. He bought Ligand convertible bonds before Reddit stocks soared.
"We are benefiting from the stock market rally, just like equity investors," said Brillois, who manages the global convertible portfolio at Lazard Asset Management. He points out that not all stocks that rose last week are linked to convertible bonds.Convertible bonds allow investors to profit from a sharp rise in share prices, but they can also pay coupons like traditional bonds.
"when stocks rise, convertible bonds will absorb a large part of the gains," Brillois said. " "the yield on convertible bonds is about 950% or 970%, while the yield on stocks is 1000%."
Two hedge fund investors, who spoke on condition of anonymity, said market volatility also provided opportunities for hedge funds to make a profit. The two investors spoke on condition of anonymity because they could not discuss their positions publicly.They buy convertible bonds of companies whose share prices have soared and hedge their positions by short selling.
"this trend has spurred a large number of funds to adopt this strategy," said a source who runs a US hedge fund.
Funds such as CQS, AQR Capital Management (AQR Capital Management), Man Group and White Box Advisors (Whitebox Advisors) are all taking advantage of this arbitrage strategy--That is, to take advantage of the price difference between bonds and stocks.
Purvino, co-founder of CNH Partners, AQR's convertible carry subsidiary, said the market frenzy "benefited private equity firms or bondholders a lot".
Gil Song, a portfolio manager at Man GLG, said the trend of unexpected swings in stocks benefiting convertible arbitrage investors was likely to become more common.
Song said: "based on recent estimates,Retail participation in the stock market has doubled in the past two years alone, and one might infer that the increase in volatility will continue for at least some time.”
Said a fund source and prime banker who spoke on condition of anonymity.Funds that buy and sell stocks and bonds at the same time have been scouring the market for opportunities created by retail buying sprees.Companies with outstanding convertible debt and overvalued shares meet the investment criteria.
"you will find that the pricing of the bond structure is inefficient," said one investor in New York. "
"when stocks go crazy, they automatically create opportunities to buy debt. Convertible bonds are indeed risky because they usually exist in speculative companies. "However, Joe Wiesoki, convertible portfolio manager at Calamos Investments, says:"whatever drives the stock-whether it's technical or fundamental-holding convertible stocks, you can retain some upside participation."
Although the rally in Reddit stocks showed signs of abating, iShares convertible Bond ETF and SPDR Bloomberg Barclays convertible bond ETF, the two largest exchange-traded funds that track the convertible bond market, both hit record highs on Friday morning.