Convertible Arbitrage

The second quarter of 2020 presented a stark contrast to the first, which had been one of the weakest first quarters in history for global equities. The MSCI World Index climbed 17.95% in the second quarter, completing one of the strongest quarters in decades. Rising investor confidence as pandemic-related lockdown measures were eased and economies began to reopen, central banks injecting liquidity, growing optimism around the development of potential vaccines and treatments for COVID-19, and some encouraging economic data led to a 35% rally from the March lows. Most credit markets also performed very well. Against this backdrop, global convertible bonds clawed back their first quarter loss and moved into positive territory for the year, with the ICE BofA Global 300 Convertible Index – a performance indicator for long-only strategies – gaining 16.41% in the second quarter. Convertible arbitrage strategies benefitted from tighter credit spreads, high volatility levels, and a surge in primary market activity, with the HFRX Relative Value Fixed Income Convertible Arbitrage Index rising 9.23% in the second quarter.

Global convertible new issuance amounted to a stellar $70.5 billion in the second quarter, which – combined with the solid first quarter total of $21.4 billion – brings first half 2020 deal volume to $91.9 billion. To put this in context, annual convertible new issuance has only risen above $90 billion once in the last decade. Recording this level of primary market activity halfway through the year suggests we may achieve an annual level not seen since the global financial crisis. With new issue valuations generally having been very attractive, the primary market has solidly re-established itself as a recurring source of alpha for convertible bond investors.

We also remain constructive on secondary market valuations. Equity market volatility is expected to remain elevated for some time, as the global count of COVID-19 cases remains on the rise and significant geopolitical tensions continue to build, with the events of the second half of the year slated to include the U.S. presidential election, the UK’s exit from the European Union, and China’s implementation of its national security law for Hong Kong, among other items. In our view, this environment – marked by high equity volatility and stable credit spreads supported by central bank asset purchasing programs – will provide ample opportunities for convertible arbitrage strategies.

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New issuance is set to reach levels not seen since 2007.

Global convertible market value is approaching $400 billion.

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