Convertible arbitrage faces heightened systemic risk
The guest warned that the convertible bond arbitrage market faces an elevated risk of a deleveraging event similar to the 2005 'Vomageddon' due to high hedge fund concentration.
The argument
He noted that hedge funds have returned to representing roughly 70% of the convertible market (up from 30% in 2020) at a time when credit spreads are extremely tight and implied volatility is low, leaving the space vulnerable to a sudden prime brokerage-driven margin squeeze if volatility drops further.
The thesis, stress-tested
✓ What validates it
- ✓A sharp drop in implied volatility triggering forced liquidations by levered convert funds
- ✓Widening of convertible bond valuations relative to theoretical fair value (cheapening of the beta)
▸ Risks discussed
- ▸Holding cash drags on performance if tight credit and low vol persist indefinitely
Hear it yourself
"Let's say, in 2020, hedge funds were 30% of our market. They're back to 70% of our market. We have really tight credit spreads. We talked about at the beginning, there is no bailout for vol going down the Coinbase example."
00:00 / 00:16