Sydney-based Basis Capital, a relative-value arbitrage hedge fund in Sydney with USD20 million under management, has recently increased the size of a credit arbitrage trade that uses credit-default swaps and is considering boosting it further. "This trade did work and Basis Capital is continuing to add to the trade," said Steve Howell, cio in Sydney, adding that as the hedge fund continues to receive inflows of cash from investors, it is putting part of that money to work for a trade on Australian packaging firm AMCOR. "There's good relative value and there's still upside return," noted Howell.
In the initial trade last June, Basis Capital bought AMCOR PACRS, a BBB minus rated reset convertible note-then trading above LIBOR plus 300 basis points, while purchasing credit-default protection on AMCOR's BBB plus rated senior paper, at LIBOR plus 60bps. Howell believed that the credit spread between the underlying senior paper and the convertible bond would narrow as the convertibles were priced too high relative to the senior paper.
The convertible bond is now trading at 200bps over LIBOR. He continued that as the spread between the credit-default swap, which still remains at LIBOR plus 60bps and the convertible, have narrowed, Basis has benefited. "The spread [between the convertible and default swap] is now at 140 basis points, making an unrealized mark-to-market profit of 80bps per annum for 5 years, simply from the credit contraction," explained Howell. He believes that the trade still makes sense as the credit spread should continue to contract as the convertible remains overpriced, though he declined to comment on how much further it could tighten. "Basis has been adding to the trade," said Howell, noting that in recent weeks it has been building up the position with inflows of cash. Howell declined to comment on the sizes of the trades or counterparties.
The fund's prime broker is Merrill Lynch. Basis Capital is up 5.63% from January to March and last year the return was 16.03%.
