The report, Convertible Arbitrage: Shifting Gears, says convertible arbitrage funds were caught in a 'perfect storm' of fundamental and technical difficulties following the fall of Lehman Brothers, resulting in a decline of 25.5 per cent in the period from 1 September to 31 December 2008.

In January, convertible bond yields were atypically more attractive than straight bond yields with similar maturity and seniority in the capital structure.

Although yields have dropped since their highs at the end of 2008, the resurgence of new issuances as well as continued cheapening of the asset class points to convertible arbitrage as a strategy that may continue to rebound in 2009 if conditions in the credit markets continue to improve, the report says.

Volatility trading of the strategy was curtailed during the large declines in 4Q 2008 and early 2009, but may come back later in the year if equity markets stabilize, albeit with a reduction in the use of leverage.

Convertible arbitrage registered one of the best performances in the Broad Index for 1Q 2009, returning 7.7 per cent.