The Absolute Convertible Arbitrage Fund (ARBIX) delivered a +1.25% return in the first quarter of 2021.

We have consistently communicated to investors that we view the ARBIX strategy as an “alternative fixed income product.” One advantage of being an alternative fixed income strategy is that ARBIX tends to be less susceptible to rising interest rates than most other fixed income products (1). The lack of correlation to interest rate moves has been a function of relatively short duration securities and the hybrid nature of convertibles which include exposure to credit and equity volatility.

Potential future inflation worries weighed heavily on fixed income investments overall in the 1Q2021. The 10 year treasury yield rose from 0.92% to 1.74% in just 90 days leading to negative returns for most fixed income strategies not related to credit. Once again, the resilience of ARBIX to rising rates was tested and the fund delivered a positive return despite a fairly dramatic move in rates.

The big story for convertibles continues to be the dramatic rise in convertible new issuance. We had what we thought was a big year in 2019 when issuance exceeded $50 billion but in 2020, when the pandemic hit, companies wanted cash to shore up their balance sheets and issuance exploded to over $100 billion. Despite the economy showing strong signs of recovery and vaccines becoming available, convertible issuance further accelerated in the first quarter of 2021. During the first quarter, $41 billion of new issues came to market – the highest level of 1Q issuance in 20 years. Technology companies continue to be lead issuers of convertibles, but consumer discretionary companies were a close second over health care related companies which traditionally hold that spot.

Investors often ask us what type of market environment is good for the strategy. Our answer is always the same – an environment where the convertible market supply and demand forces are healthy. On the demand side, a healthy and stable environment is one where there is the proper mix of buyers between long only investors and hedge fund arbitrageurs. We don’t want a demand environment with too many hedge funds looking for arbitrage opportunities. Currently, we still see healthy demand dynamics as the majority of buyers remain long only funds and hedge funds remain in the minority. On the supply side, we benefit from increased availability of merchandise which are replenished via the new issue market. Obviously, given the record issuance of convertibles lately, the supply side of the equation is very strong.

In the long term, more issuance should create a much larger and longer lasting opportunity for arbitrageurs like ourselves. Simply, the more securities we have to pick from, the more likely we will find opportunities. In the short term, recent heavy issuance has weighed on prices and short term performance as it will take time for the market to absorb all of the new securities. As a result, convertible valuations have cheapened significantly the past month creating a better expected return for the next 12 months and more. More specifically, despite the narrowing of high yield spreads in junk bonds, implied credit spreads of small/mid cap companies in the convertible market have widened and trade 100 bps or more wider than high yield. These spreads are wider despite significantly lower historical default rates than high yield, less interest rate risk and a large element of credit hedging/volatility exposure resulting in much less net risk exposure for investors. In our 30+ years in convertible bond markets, we have never seen the convertible asset class grow so rapidly which, we believe, sets up well for arbitrage opportunities for years to come.

(Definitions, supporting data and risk disclosure below)

government regulations, differences in accounting standards and other factors. Investments in emerging markets involve even greater risks. Small, mid and large cap stocks are subject to substantial risks such as market, business, size volatility, management experience, product diversification, financial resource, competitive strength, liquidity, and potential to fall out of favor that may cause their prices to fluctuate over time, sometimes rapidly and unpredictably. The Fund is actively managed and may experience high turnover. This may cause higher fees, expenses and taxes, which could detract from Fund performance.

These views are subject to change at any time based on market and other conditions, and Absolute Investment Advisers disclaims any responsibility to update such views. No forecasts can be guaranteed. These views may not be relied upon as investment advice or as an indication of trading intent on behalf of any Absolute Investment Advised investment product.

Investors should carefully consider the Fund’s investments objectives, risks, charges and expenses before investing. This and other information is in the prospectus, a copy of which may be obtained by calling (888) 992-2765 or visiting the Fund’s web site: www.absoluteadvisers.com. Please read the prospectus carefully before you invest.