Relative-value trades traditionally snapped up by hedge funds and bank prop-trading desks are now increasingly open to other investors, says Anurag Mahesh, Asia-Pacific head of global investment solutions at Deutsche Bank Private Wealth Management (PWM).
"The market turmoil has presented a lot of market dislocations in equity, currency and credit that can be made available to real-money investors, such as private wealth clients," says Singapore-based Mahesh.
For example, following the credit crisis that erupted last September, bond prices fell more dramatically than the risk of default rose, creating a yawning gap between the price of credit default swaps and their underlying bonds, he adds. This was the result of bond prices being pushed down to abnormally low levels by investors under pressure to de-leverage and reduce the size of their balance sheets.
Mahesh says Deutsche Bank PWM has helped clients access such 'negative basis' trades.
"Similarly, we have also seen such opportunities across different parts of the capital structure on a bank's balance sheet," he says. "For real-money investors retaining strategic equity positions in a bank, it has been possible to generate incremental returns without assuming any incremental risk by exploiting the pricing differences between preferred and common equity."
These kinds of opportunities also presented themselves around the announcement of rights issues for some of the companies, adds Mahesh.
Other relative-value opportunities -- such as dual-stock listing arbitrage, which involves benefiting from the price differential between stock price of the same entity listed on two different exchanges -- are available at levels not normally seen before the crisis.
In the past, such opportunities -- which can provide return with little risk -- would be arbitraged away pretty quickly by the likes of hedge funds and proprietary trading desks of banks, says Mahesh.
That's because many banks are now constrained by reduced trading limits, while hedge funds have pulled a lot of capital out of the markets, meaning there is significantly less money chasing such trading opportunities.
Another interesting development is that clients are now actively seeking to limit downside risk. "Clients feel it's very important to have mark-to-market stability during the life of the transaction," says Mahesh. "They are asking for some form of lifetime price floors, so that they are able to sell the investment back to the bank any time during the life of the transactions, at a pre-determined floor price."
"A lot of market players had to unwind their investments during the crisis -- not because they didn't believe in them anymore, but because the price fell down a lot during the crisis," he adds. "Investors today are definitely more focused on 'black swan' events -- extreme downside risk possibilities -- and we have responded by building in these downside lifetime market-value protection features."
Moreover, it's not very expensive to buy this kind of insurance for credit or relative-value arbitrage situations such as negative-basis trades, because they are way out-of-the-money options, says Mahesh. And the probability of the credit market, unlike a stock, to drop by 15% over a short span is relatively low, he adds.
This may help explain the reason for Deutsche Bank PWM's client portfolios currently having about 40% in fixed income (across cash, government bonds and corporate bonds), 25% invested in equities (across developed and emerging markets) and the remaining 25% spread across alternatives such as hedge funds, private equity, real estate and commodities.
The firm started the year with a 60% allocation into fixed income, 20% in equities and 20% in alternatives, says Mahesh.