Convertibles outright returns down 0.3%, hedged convertibles down 2.1% in August, Citigroup says

By Evan Weinberger

New York, Sept. 5 - A tough July bled into a difficult August for the convertibles market, a new Citigroup report released Wednesday said. Both outright and convertible arbitrage investors lost early in the month, but outright investments regained much of the value lost early. Convertible arbitrage investors were not as fortunate.

"Through the first two weeks, as stocks fell 3.6%, [high yield] spreads pushed out an additional 40 [basis points] and liquidity within convertibles dried up, many widely held convertibles lost two to four points on swap," the report by Citigroup convertibles analyst Adrian Miller said. "The latter half of the month saw markets stabilize and improve which led to convertibles recovering approximately two-thirds of the loss in value."

According to the report, the outright convertibles market lost a total of 0.3% in August. The outright return on convertibles is up 4.4% for the year, as compared with a 3.1% increase for the underlying stocks on the year.

Convertible arbitrage strategists saw their losses go as deep as 3.7% at the middle of the month before rallying somewhat and ending August down 2.1%. The report does stress, however, that it is difficult to gauge hedge fund results when liquidity is strangled. "Some convertible arb portfolios, depending on the portfolio construction and trading activity, could have made it into the black by the end of August, while some funds could have suffered losses in excess of what [Hedge Fund Research] is currently estimating," Miller wrote.

If HFR's 2.1% loss for August proves to be accurate, the convertible arb strategy would be up 2% for the year, Miller added.

Among the best-performing convertible issues for August were Midway Games Inc.'s 7.125% convertible senior notes due May 31, 2026, which returned 56.32% versus a common stock loss of 11.31%. For the year, the Chicago-based video game producer's convertibles are up 50.84% against a common stock loss of 22.49%.

Also performing well in August were Priceline.com Inc.'s 0.5% convertible senior notes due Sept. 30, 2011, which had a 28.339% return against a 30.06% return on the common stock. For the year, the Norwalk, Conn.-based online travel agency's convertibles are up 76.13% against a common stock rise of 90.28%.

Among those moving down big were Countrywide Financial Corp.'s 0% LYONs due 2031, which lost 29.31% of their value versus a 29% common stock loss. The Calabasas, Calif.-based mortgage lender, the largest in the United States, has seen its LYONs drop 52.97% of their value versus a common stock loss of 52.52% for the year.

Citigroup charted aQuantive Inc.'s 2.25% convertible senior unsecured notes due Aug. 15, 2024 as the best performing convertibles for the year so far. The convertibles have returned 158.23% versus a common stock gain of 169.18% so far in 2007. The Seattle-based internet advertising agency, and since the middle of the month Microsoft subsidiary, saw its convertibles return 0.4% in August versus a common stock return of 0.35%.

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