Why in period of high issuance, convertible arbitrage does well?
High issuance leads to lower pricing of convertible debt (since the market has to absorb more of these instruments). The new issuance is brought to market at a discount to the convertible’s theoretical valuation, providing an opportunity for pricing arbitrage. Lower pricing leads to more attractive opportunities for the active manager (classic strategy is to buy undervalued convertible bond and short the relatively overvalued stock).
More generally speaking, periods of high issuance increase the investable universe for convertibles and creates new opportunities for convertible investors (e.g., diverse groups of companies, different sectors, first-time issuers, etc.).
From the CFAI text:
Convertibles are often issued sporadically by companies in relatively small sizes compared to straight debt issuances, and thus they are typically thinly-traded securities. Moreover, most convertibles are non-rated and typically have fewer covenants than straight bonds. Because the equity option value is embedded within such thinly-traded, complex securities, the embedded options within convertibles tend to trade at relatively low implied volatility levels compared to the historical volatility level of the underlying equity. Convertibles also trade cyclically relative to the amount of new issuance of such securities in the overall market. The higher the new convertible issuance that the market must absorb, the cheaper their pricing and the more attractive the arbitrage opportunities for a hedge fund manager.
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