Balancing risk and reward: The long-term performance of Lazard Rathmore strategy

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Published on
March 6, 2024

Discover enhanced returns through innovative approaches, risk reduction, and Lazard's Rathmore strategy's impressive track record. Uncover a compelling investment avenue offering equity-like returns with bond-like risks.

What is a Convertible Arbitrage Strategy?

Within a convertible arbitrage strategy, a long convertible bond position is paired with a short stock position in the equity of the same company, creating a hedged pair.

How Can a Convertible Arbitrage Strategy offer enhanced return potential?

In addition to generating returns from Coupon and Pull-to-Par via the strategy’s long convertible bond exposure, a convertible arbitrage strategy can benefit from additional sources of return, associated with the use of position-level, short stock hedges.

For example, the strategy can receive additional income from short sale proceeds associated with position-level stock hedges. Also known as “short rebate,” cash received from selling short the equity underlying the convertible (to implement a position-level hedge) sits with the prime broker and earns the overnight rate. This supplements the income received from the bond’s coupon.

Most notably, however, the strategy can benefit from and monetize market uncertainty, thus generating an additional source of returns referred to as Volatility Yield, which can enhance investors' return potential as compared to traditional fixed income investments.

How Can a Convertible Arbitrage Strategy reduce risk?

Importantly, not only can the use of a position-level stock hedge allow for enhanced return potential through the extraction of volatility yield (as outlined above), but it can simultaneously serve to reduce the credit risk taken via the strategy’s long convertible bond position. To be more specific, in a worst-case scenario for a fixed income investor, should the long convertible bond that the strategy holds default, the equity underlying the convertible, which the strategy is short, will typically be valued at zero, thus providing a significant offset.

On average, $0.50 of every $1.00 of exposure within a convertible arbitrage strategy can be hedged with a short stock position in the equity of the same company, thus leaving investors with approximately half the credit risk as compared to traditional fixed income investments. The use of position-level equity hedges also serves to reduce the volatility of investors’ returns.

Are there any additional benefits of a Convertible Arbitrage allocation from a fixed income perspective?

A convertible arbitrage strategy is typically low in duration (<2 years) thus providing relevant interest rate risk mitigation. In addition, given the strategy’s ability to benefit from elevated levels of market volatility, the strategy has a low correlation to traditional fixed income, thus providing meaningful diversification within a fixed income portfolio.

What does this ultimately mean for investors?

Over time, a convertible arbitrage strategy, such as Lazard’s Rathmore strategy, can provide investors with equity-like returns, but with bond-like risk. Since inception, the Lazard Rathmore strategy has outperformed the Russell 2000 Index by 90 bps, but with a daily volatility annualized of less than that of the Bloomberg US Aggregate Bond Index, yielding a Sharpe ratio of 1.7.

Why Lazard for Convertible Arbitrage investing?

The Lazard Rathmore team is one of the largest and longest tenured convertible arbitrage managers operating in the space today. The team comprises 12 dedicated investment professionals, including four senior portfolio managers, who each have over 25 years of experience in the space and have been working together for a minimum of 10 years. The strategy has a continuous track record of over 16 years, spanning varying market cycles and market shocks, including the Global Financial Crisis. Few other convertible arbitrage peers survived this market event, which is a testament to the team’s depth of experience and resources.

The team’s edge in extracting value is backed by Lazard Asset Management’s full breadth of resources. This includes access to its global fundamental analysts—which enables the team to leverage investment insights from across the platform and gain direct access to senior management of issuing corporations. The team also works closely with the firm’s ESG specialists. This supplements their integrated approach to ESG, which is centered on direct, issuer-level engagements.


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