Hedge against bond market decline

During the 1998 stock market decline of 21%, I was a managing partner of two convertible arbitrage hedge funds. It should have been a home run for the convertible arbitrage community, but there was also a decline in the fixed income market that happened at the same time.

The long side in the convertible arbitrage position is supposed to decline at a much slower rate than the short side equity decline.  That is where the profit comes from. In 1998, as in today’s market, that is not happening. I was not alone. There was a flight from quality, as that was the most liquid part of the market.

This problem led most of the convertible arbitrage community to try and figure out a way to hedge the long side against fixed income decline at the same time as equity declines.

The futures market offered a partial solution, but many of us did not use it because of various reasons. The main reason was that outside counsel advised us that if we were to use futures we had to register as a commodity pool operator with the CFTC, and we were unwilling to put ourselves in another regulatory situation.


“The Simplify Interest Rate Hedge ETF (PFIX) seeks to hedge interest rate movements arising from rising long-term interest rates and to benefit from market stress when fixed income volatility increases.

T­he fund holds a large position in over-the-counter (OTC) interest rate options intended to provide a direct and transparent convex exposure to large upward moves in interest rates and interest rate volatility.Using OTC derivatives, usually only available to institutional investors, PFIX is designed to be functionally similar to owning a position in long-dated put options on 20-year US Treasury bonds. Since the option position is held for an extended period, the ETF provides a simple and transparent interest rate hedge.”

For more information, go to the Simplify website.

The following graph portrays PFIX in relation to SPY, the ETF of the S&P 500. Close as of the close of Tuesday, September 27, 2022.

The swap from SPY to PFIX is at the Green vertical lines.

The trade would make an interesting momemtum-based pairs trade.