What does the moderate cross-sectional average return of fixed-income arbitrage funds imply?

The moderate cross-sectional average return of fixed-income arbitrage funds signifies that these funds tend to provide moderate returns that are balanced with the objective of achieving meaningful diversification benefits. Fixed-income arbitrage strategies typically involve exploiting pricing inefficiencies between related bonds, such as government securities and interest rate derivatives. The nature of these strategies often leads to lower expected returns compared to equities and certain other asset classes, as they tend to be more focused on relative value investments.

Moreover, the investment approach behind fixed-income arbitrage allows these funds to reduce overall portfolio risk through diversification. By engaging in practices that exploit mispricings within the fixed-income market, these funds can create positions that offset risks across different bonds and interest rate products. This means that while returns are moderate, they can effectively contribute to risk-adjusted performance in a diversified investment portfolio.

Given this context, it is evident that the moderate returns associated with fixed-income arbitrage funds come with the added benefit of providing meaningful diversification, making them an important component for investors seeking to manage risk within their overall asset allocation.