Fixed Income Relative Value and Credit Arbitrage Strategies
The hedge fund styles that look to exploit pricing inefficiencies related to fixed-income securities are commonly referred to as fixed income relative value and credit arbitrage. These styles also come in many shapes and sizes. A relative value manager looks to exploit inefficiencies in the pricing of fixed-income securities by making bets on the relative rather than absolute value of government bonds, agencies or corporate debt securities, and their related derivatives.
Managers in these styles trade in a wide range of securities, whether they are U.S. or international government-issued bonds, corporate bonds, agencies bonds, or hybrid securities such as convertible bonds. Managers in this category use a complex set of tools to hedge or profit from mispricing related to various types of bonds or to each other. Tools might include interest rate swaps, swaptions, caps, floors, credit default swaps on single names, baskets or indices, and many more.
One of the most basic characteristics of relative value managers is that they seek to find trades where one security has temporarily become cheaper or more expensive than another identical or very similar security.
A certain type of U.S. government bond called a Treasury inflation-protected security (TIPS) might be trading cheap or rich compared to the price of a nominal bond of the exact same maturity plus the expected rate of inflation. A hedge fund manager could ...