What Drives the Performance of Convertible-Bond Funds?

This paper examines the performance of US mutual funds investing primarily in convertible bonds. Although convertible-bond funds are popular investment vehicles, their return process is not well understood. We contribute an analysis of the complete universe of US convertible-bond funds proposing a set of multi-factor models for the return generating process. In spite of the well-known hybrid nature of convertible bonds, the return process of convertible-bond funds cannot be fully explained by factors typically related to stock and bond markets. Thus, we consider additional variables accounting for the option-like character of convertible bonds. Surprisingly, multivariate cross-sectional analyses show the existence of a significant positive relationship between a fund's performance and its asset composition. Similar to Agarwal et al. (2006) we show that this result can be explained by factors related to investment opportunities in the convertible-bond market and trading strategies related to convertible arbitrage, as typically performed by hedge funds. Overall, convertible-bond funds have a performance as measured by alpha that is comparable to passive investment strategies in stocks, bonds, and convertible bonds. This average performance is the result of weak selection skills and successful timing of strategies related to convertible arbitrage.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=967988