Prodigy Asset Management in Taiwan is preparing to launch its second convertible arbitrage fund and is now finalising arrangements with its likely prime broker, Morgan Stanley. The $200 million manager wants to provide a hedged product with lower volatility to complement its first fund, which does not short.

The firm was established last year by the former derivatives team at Yuanta Core Pacific Securities, says Samuel Wang, founder. Most of its assets are managed for individual clients, like a managed account, but in March this year it launched a convertible arb fund that now has $37 million under management. Its clientele is mainly Taiwanese corporations, with a small portion individuals' money.

The firm invests in both New Taiwan dollar-denominated convertibles as well as euroconvertibles issued by small- to medium-sized companies. Thanks to the teams' experience at local houses such as Yuanta, Grand Cathay and President, Prodigy has good relations with local brokers, which is vital to getting access to convertibles at IPO.

"We're all derivatives people," Wang says. "We don't come from fund management houses. So we only look at risk. We test our portfolio to see what happens if, say, the market falls 10%, as opposed to just trying to test which way the market will move."

Few investors in Taiwan pay attention to securities' covenants and miss things such as reset clauses, which a careful convertible arbitrageur can turn into profit, he adds. Domestic convertibles offer the best value. Moreover, Prodigy's close relationship with local brokers allows it to trade domestic convertibles through the stock exchange, which is difficult for foreigners.

Until now, Prodigy handled dealing itself, as it was only doing arbitrage trades. Its custodian is Standard Chartered Bank. But the new fund is to be hedged, to reduce its volatility, and that requires shorting stocks. Although Prodigy can swap credits with commercial banks, shorting by itself would require up to 30% of the securities' value in collateral. Via a prime broker, Prodigy only needs to put up 5% in collateral. Wang says the firm wants to launch the new fund by December.

The first, unhedged fund has so far returned 16.5% since its March inception, and the firm is targeting 20% after 12 months with low volatility.