(Dow Jones) More hedge funds and other investors are gambling on the potential for profits in certain auction-rate securities, more than a year-and-a-half after the market failed en masse.

In some cases, activist investors are buying up the shares at discounts on secondary markets, then pressuring funds to buy them out at or near par. Investors are seeking advantange in a market where many investors feel trapped and are struggling to trade in or establish a value for their illiquid securities.

Financial advisory firm Duff & Phelps, which has been helping a variety of investors, mostly companies, value their auction-rate securities, is seeing increased interest in buying the shares at discounts, said Dwight Grant, managing director in the firm's San Francisco office and part of its financial engineering practice.

Auction-rate securities are bonds with interest rates meant to be reset periodically at auction. Many financial advisers promoted them as liquid, but the $330 billion market seized up in February 2008 as credit markets tightened and auctions attracted no bidders. That left investors stranded.

Some investors can afford to hold their auction-rate shares until a solution, and those aren't likely to sell for much less than 90 cents on the dollar, Grant said. Others need the money more urgently. Potential buyers are examining those holdings and, in some instances, offering 70 cents on the dollar with the expectation that they will have to hold the shares for two to three years before selling them.

"There clearly is an acquisition market," and purchases are happening even more frequently now, he said. Some hedge funds are carefully "identifying securities that they believe have particularly desirable characteristics," Grant said.

"There's a great uncertainty around exit and it's going to vary a great deal by issuer, but it is occurring," he added. As shares are redeemed, more of the securities will be concentrated in the hands of large institutions, which have an interest in getting the issue resolved, and can go directly to the issuer and try to work out solutions, he said.

Maury Fertig, chief investment officer at Northbrook, Ill.-based Relative Value Partners, which oversees $400 million in customized accounts for wealthy families and small institutions, has purchased about $55 million in auction-rate securities issued by closed-end funds, mostly Nuveen Investments, some at 70 cents on the dollar. He has made purchases as recently as last week, and has had about $15 million of the shares redeemed at par. He's confident there'll be more redemptions in 2010.

"It's going to be a slow, steady climb in terms of redemptions," he said.

A key factor in valuing auction-rate securities is the formula that determines the maximum rate its issuer will have to pay shareholders when auctions fail. Some are tied to the London Interbank Offered Rate, an interest rate at which banks can borrow, and others have multiple indexes, Grant said.

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