Convertible arbitrage: Offering niche alpha and diversification
Convertible arbitrage can offer asset allocators the opportunity to diversify traditional and alternative exposures, tap into idiosyncratic sources of alpha, and potentially take advantage of market volatility.
Originally published in October 2025 by our U.S. partners.
Written by Mitch Livstone, Chief Investment Officer Arbitrage and Hedging Solutions, Sladja Carton, Institutional Portfolio Manager Liquid Alternatives, and Seth Gold, Portfolio Manager, Convertible Arbitrage
Highlights
- Convertible arbitrage is a relative value alternative investment strategy that typically has had very low equity beta and low correlation with equities and interest rates. Convertible arbitrage alpha comes from mispriced securities, due to segmented market dynamics, and unexpected stock swings that can be monetized due to the positive convexity of convertible bonds.
- Convertible bonds are multidimensional instruments, having exposure to credit, volatility, equity and interest rates, packaged in complex and nonlinear structures. Therefore, successful implementation of a convertible arbitrage strategy requires a high level of sophistication, depth of experience, and informed analysis.
- The convertible bond market is small compared to credit and equity markets, constraining the capacity of convertible arbitrage strategies.
- Convertible arbitrage can be used by asset allocators to diversify traditional and alternative exposures, source idiosyncratic alpha, and take advantage of market volatility. The return profile of convertible arbitrage historically offers absolute return with low volatility and low correlation to the equity and bond markets, typically in a highly liquid format.
- We believe the current market environment offers an especially attractive risk reward opportunity for convertible arbitrage driven by more active primary issuance, increased participation of arbitrage investors in the market and higher activity of corporate events.
Convertible arbitrage is an investment strategy that hedge funds have successfully employed for many decades. This approach aims to generate alpha in a market neutral fashion by exploiting pricing inefficiencies in convertible securities. The key value proposition of convertible arbitrage is that it may provide investors access to uncorrelated niche alpha, typically with a lower volatility profile compared to many other hedge fund strategies.
The convertible market is liquid and sizable, but still relatively small compared to equity and fixed income markets. Therefore, convertible arbitrage strategies are typically capacity-constrained, in total representing approximately 10% of hedge fund assets.1 Another barrier to entry is the requirement for active and specialized management to successfully extract alpha amid fluctuating credit spreads, volatility, and equity prices.
A comprehensive understanding of market dynamics and deep expertise in investment structuring are essential for successful results. While we believe that a well-implemented, diversified convertible arbitrage strategy can achieve its objectives across various market environments, we view the current market conditions as offering a particularly attractive opportunity set for convertible arbitrage investing.
1 Preqin Global Report, Hedge Funds 2024.
