Bears Beware: Bonds Are Back and Ready To Beat 'Em

January 29, 2001 ( are back in the driver's seat and it couldn't be better timing for fixed-income arbitrage managers seeking normalcy after the reckless bond markets of the last three years.

It started with the Asian Crisis in 1997 and continued through a Russian currency crisis in 1998. A boom in the high-yield market in 1999 was greeted by a slump in 2000 and an overall bond market liquidity crisis, while an inversion of the yield curve and a dislocation between swaps and corporate curves still hovers in the background.

But times they are a-changin’ and fixed-income arbitrage managers have seen an increased interest in their funds thanks to a bull stock market that seems to be steadily limping out to pasture.

Sy Lotsoff, senior managing director at Lotsoff Capital in Chicago, is watching interest peak for fixed-income arbitrage strategies.

“We are getting a lot of interest, primarily from fund of funds that have been leery to do fixed-income strategies because of Long-Term Capital,” Mr. Lotsoff said.

The renewed interest is not due to amnesia, but mainly because of low correlation to equities and the strict risk controls in place in the management of the Lotsoff Global Interest Rate Hedge Fund, according to Mr. Lotsoff.

He employs collar hedges that allow the firm to keep only a finite amount of money at risk at a given time. The $300 million fund’s diversification in various bond strategies is also attractive to investors, said Mr. Lotsoff.

Theresa Havell, president and chief investment officer at Havell Capital Management, New York, is predicting a bond market comeback. With benign interest rates coupled with increasing liquidity, the bond market will gladly take back what it gave up the last three or four years, she said.

She expects rates of return for her fixed-income arbitrage portfolios to be once again in line with equity returns after trailing the last four years with returns in the low teens.

“Bond investors face a dramatic new world with an altered and higher return potential,” Ms. Havell wrote in a white paper entitled, “Death, Eulogy and Rebirth of the Bond Market.”

Ms. Havell is ushering in the new bond market as one of the survivors of the bond market turmoil of recent years.

“What is being successful?” Ms. Havell asked, “Being successful in 1998 was not going out of business.”

The most surprising driver of the bond market and overall economic breakdown for Ms. Havell has been the disparity between swap rates and corporate bonds.

She said this is an indicator of economic slowdown, which ultimately means that bonds may once again come in favor as they outperform equities. Driven by the corporate advantage of bond issuance, bond markets will once again return to normal patterns, Ms. Havell predicted in her paper.

So far, Ms. Havell has seen inflows to her fund pick-up in the last quarter of 2000. She expects more of the same as investors see the results of their equity managers.

Ms. Havell calls her bond strategy “relative value fixed income.” The management technique differs from that of other managers in that she employs one to three times leverage and takes on other forms of risk other than duration risk by investing in more types of bonds, she said.

Havell Capital manages $200 million in separate accounts and in the Universal Bond Fund.

– Susan L. Barreto, Senior Reporter,


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