WEST PALM BEACH, FL (www.hedgeco.net) – Increasing number of hedge funds are embracing less risky municipal bonds, the strategy dubbed munitrade arbitrage, is a simple trade in U.S. municipal bonds.Analysts believe the strategy has become attractive to hedge funds from the perceived tax-free gains of more than 3 percent in 2005 so far and more than 8 percent during the past 12 months. Suchgains compares more in favorable terms to the current flat returns posted by most hedge funds so far in 2005.<\/p>\n
Hugh McGuirk, a portfolio manager in the municipal-bond department at T. Rowe Price said, \u00c3\u00af\u00c2\u00bf\u00c2\u00bdThis trade is becoming a dominant force in our market, and it appears to be growing.” Increasing number of hedge funds and money-management firms have continued to execute the municipal bond trades, according to McGuirk.<\/p>\n
According to reports, hedge funds and other savvy investors are buying up, \u00c3\u00af\u00c2\u00bf\u00c2\u00bdlonger-term municipal bonds, which lately have sported yields of about 4.1 percent for 20-year notes.\u00c3\u00af\u00c2\u00bf\u00c2\u00bd Those funds will then set up Trust structures to convert the new bond instruments into tax-free short-term municipal tender option bonds, which will then be marketed to investors. According to the theory behind this trade, these bond products pay a floating interest rate in the range of 2.4 percent thereby pocketing the \u00c3\u00af\u00c2\u00bf\u00c2\u00bdcarry\u00c3\u00af\u00c2\u00bf\u00c2\u00bd between the 2.4 percent and the 4.1 percent; such trades are fully executed with borrowed funds.<\/p>\n
Assuming a hedge fund manager purchases $100 million of long municipal bonds yielding 4.1 percent with investors money, and financing the purchase by issuing short-term municipal bonds paying 2.4 percent, that manager has the potential to pocket about $1.7 million each year if the short term interest rate level remains the same. This trade is more complex than it seems and obviously not for managers without advance knowledge of arbitrage plays.<\/p>\n
Narayan Prasad, president of hedge fund firm Anchor Capital Group, said the trade is “very attractive.” The Anchor Capital Group devotes most of their trading on the Municipal bond arena, with about $250 million of investor assets under management.<\/p>\n
Paul Oranika
Editor-in-Chief
HedgeCo.Net
Email: Editor@hedgeco.net<\/p>\n
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