Tell me about the CQS Diversified Fund. What is its goal and which investors does it target?

It is one of the multi-asset strategy funds that we at CQS manage along with our long only credit multi-asset offering.

The Diversified Fund provides investors access to a range of CQS-managed hedge funds that span a number of underlying strategies where we have significant expertise and a proven track record.

It is designed to offer attractive returns with controlled volatility in a single-manager, multi-fund structure.

We look to meet this objective by allocating across a spectrum of investments; we manage the portfolio by dynamically rebalancing towards opportunities and strategies as value appears in them.

A feature of this approach is that the fund has historically delivered attractive returns and low correlation to traditional equity and credit markets.

Can you explain the concept of convertible arbitrage to me?

Convertible arbitrage is a key strategy in the Diversified Fund.

A convertible is typically a fixed-income instrument that can be converted into shares and combines the attributes of both bonds and equities.

Convertible arbitrage is a relative value strategy that seeks to benefit from mispricing in individual convertible securities.

These mispricings can be exploited by hedging the underlying credit or equity risk to isolate value.

What creates the inefficiencies between the value of a company’s equity and its convertible bonds?

There has been a material change to the convertible market over the past few years as the investor base has rebalanced away from leveraged market participants towards long only investors.

We are active both in the long only space and the arbitrage space.

Market inefficiencies are created by a number of factors, including pricing of securities at new issue; treatment of securities in response to corporate events/actions; and the flow of funds both in and out of the asset class.

We believe the exit of many market participants in recent years has improved the opportunity set, particularly in convertible arbitrage.

What strategies are CQS’s credit-focused hedge funds pursuing at the moment?

In a market environment where the absolute level and range of credit spreads, and also volatility, are all relatively low, finding value requires detailed fundamental analysis and, perhaps, a greater attention to short-biased strategies.

In terms of long value-driven opportunities, we find particular value in US and European asset-backed securities and have recently raised that strategy’s weighting in the Diversified Fund.

We also continue to actively build shock absorbers into the fund using a variety of instruments including single name and index short positions as protection.

What benefit do the hedge funds offered through CQS Diversified Fund have for investors? How can they be used in the portfolio of institutional investors?

The underlying strategies are able to take both long and short positions, enabling the fund to potentially benefit both from declining and rising markets.

The fund is designed to offer attractive returns with controlled volatility.

Investors have been attracted to the strategy as they seek to diversify their exposures and to reduce overall portfolio volatility.

Is it difficult to convince investors about the benefits of market-neutral strategies when markets are soaring?

In our experience many institutional investors in the post-GFC world focus on market-neutral strategies, particularly when they perceive markets to be frothy.

The Diversified strategy has had material inflows over the last 12 months, largely from institutional investors as they seek to diversify their exposures.

What do you think of the hybrids being offered at the moment? I’ve come across quite a few managers who are turning up their noses at the ‘new’ hybrids versus the ‘old’ ones.

These are more complex products with elevated risks of losses and there’s likely to be a large amount of supply.

If you look at the financial sector, new style convertible contingent liabilities ('cocos') are a form of product designed specifically to absorb losses.

They need to be either written down or converted into equity if a bank’s core equity ratio falls below a pre-determined level.

Coupon deferrals are also mandatory if capital ratios fall below certain levels.

So it is understandable they have received a mixed reception.

However, regulators have determined that all Additional Tier 1 debt going forward must be in this new format to qualify as Tier 1 capital.

Ultimately, it comes down to an investor’s evaluation of risk and reward.

The concept of ‘bailing in’ bond holders seems to be gaining some sway in David Murray’s Financial System Inquiry and internationally. Do you have some thoughts about this?

Senior bond 'bail in' regulation is already in place in some countries and is in the process of being implemented across the European Union where legislation will become effective from 2016.

In the past, failing banks have typically been rescued by governments who used taxpayer money to fund their bailout.

The introduction of 'bail in' regulation aims to reduce government intervention and will force losses on to bondholders.

'Bail in' is now part of the international financial landscape and will be the preferred tool in bank restructurings and resolutions.

Peter Warren is the CQS senior portfolio manager and is also a member of the CQS executive committee. Prior to joining CQS in early 2008, Peter worked at Goldman Sachs International for over 14 years. He held a number of positions in the convertible bond and equity businesses, and was most recently managing director in European equity capital markets and head of convertible origination and equity syndicate.