Hedge Fund Investing: A Practical Approach to Understanding Investor Motivation, Manager Profits, and Fund Performance

Understanding the Investment Process and Portfolio Construction Objectives

A convertible arbitrage manager follows a combination of top-down and bottom-up analysis to develop themes, evaluate ideas, and make portfolio investment decisions. In this regard, the strategy has a process that contains elements of global macro and both long and short equity investing and credit arbitrage.

Top-down analysis involves evaluation of the relatively large universe of convertible instruments and high-yield bonds using screens that are proprietary to a particular fund. Top-down screens can sort by geography or industry or based on value versus growth outlooks. Bottom-up screens can be fundamental value-driven, event-driven, quantitative, or technical or based on options analysis and relative value. Once companies make a list of potential candidates, they are ranked and subjected to in-depth fundamental analysis.

Ideas that are identified by the research team are presented to the portfolio manager and trading teams for further review and analysis. Once a company-specific situation has been identified by the research team and reviewed by trading, a decision on the entry and exit prices, specific instruments to be bought and sold, and hedging strategies are developed. Approving a new position is often a collaborative effort using input from research, trading, financing, risk, and other teams prior to the portfolio manager or an investment committee approving and then sizing a trade. New ideas are ...