Fixed income arbitrage is but one of many different types of hedge fund trading strategies. Some of the other large and successful types of funds are long short equity, global macro trading, and other types of arbitrage.
Fixed income arbitrage is when you trade two different, usually barely different, securities and earn the spread or carry. Sometimes hedge fund managers will go pretty far out and trade some less then perfectly correlated securities against each other. Some managers will go long emerging market securities and short some Treasury securities to fund the trade. While this is a spread trade it is not a perfect hedge. Both assets can trade at widely different levels from each other. In good times you can earn a lot of excess return or carry but when things get bad you will get rocked as investors flee emerging markets like a theater on fire and run into the fireman’s arms, also known as Treasury securities.
Because of the different ways in which you can supposedly “arb” and make money it is important that you know how your manager actually executes their arbitrage strategy to ensure that it is not just a harebrained funding scheme. You can successfully arb out solid returns but if they look way too good to be true then you might want to look under the hood.
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