‘Event-driven’ hedge funds leap into lead after rush to invest
When a hedge fund manager makes a paper profit of $1bn in a single day, it attracts attention. Bill Ackman’s 9.7 per cent stake in Allergan, the maker of Botox injections, rose by that much last month when he revealed he was working with Valeant Pharmaceuticals on a hostile bid for the company. It was a trade that attracted wide comment from lawyers and rivals for its unusual structure and its audacity, but for investors it was simply the fact of such a large profit that caught the eye.
It was another example that a creative hedge fund manager can make his own profits, no matter what is going on in the wider market, and the best justification yet for the headlong rush to put money into “event-driven” hedge fund strategies over the past year. The activists, such as Mr Ackman and peers including Dan Loeb and Barry Rosenstein, whose goal is to cajole companies into corporate activity, have generated most of the headlines, but the phenomenon has been seen across the whole category of event-driven funds. These include managers who make bets around mergers and acquisitions, for example, or even around regular events such as earnings or share buybacks. In all, event-driven funds attracted $29.6bn in new money last year, more than any other hedge fund category, and a further $4.1bn in the first quarter of 2014, according to data provider Hedge Fund Research. Assets under management are more than double what they were in 2008. These funds have outperformed the hedge fund industry as a whole in all but two quarters since the start of 2011 – making them even more popular – and even as the industry has suffered two rocky months, turning in negative returns overall, event-driven funds have stayed profitable. The question, as equity market valuations get more stretched and investors become more nervous about a correction, is whether the boom in event-driven funds will prove to be a bull market phenomenon, or whether these managers go on to prove they have found the holy grail of hedge fund investing, uncorrelated returns. SkyBridge Capital, a fund of funds, has 40 per cent of its portfolio allocated to event-driven strategies, and although it has dialled back investments with managers who are the most correlated with the stock market in recent months, founder Anthony Scaramucci says he still believes activists in particular have further to run.
“Every 30 years in the modern era, corporate America has had to go through a period of slimming down and restructuring,” says Mr Scaramucci. “In the 1980s, it was driven by the corporate raider, now it is the activist. Every 30 years, the companies get fat, they get clubby.” Some of the most conservative event-driven strategies of recent years have lost their allure as more and more funds have crowded in, according to Barry Gill, portfolio manager at UBS O’Connor. These plain vanilla strategies include short-term bets around specific triggers such as earnings, usually made up of betting in favour of one stock and short selling a rival. “The more capital, the lower the returns, since there are lots of people with similar ideas and ways of thinking about the world,” says Mr Gill, adding that the bias towards using mid and small-cap stocks has exacerbated losses in this subsector in recent weeks as small-caps have sharply underperformed. If these conservative strategies are played out, and activism is halfway through its cycle, Mr Gill says, the next bright spot within event-driven strategies is merger arbitrage. A boom in US merger and acquisition deals appears to be spreading to Europe, not least via Pfizer’s $100bn-plus bid for AstraZeneca, giving traders numerous options to bet on the outcome of the battle and on the likely shifts in the two companies’ shares and bonds. A recent rise in European deals has prompted hedge fund investors to seek funds with exposure to the region, and for hedge funds themselves to look to hire more managers who are able to trade such situations effectively. A recent report by Lyxor Alternatives, a France based fund of hedge funds, referred to an “M&A frenzy”, arguing that the European merger cycle would mean a large number of opportunities would open up for managers. Andrew Garthwaite, chief global equity strategist at Credit Suisse, argued at a recent conference in London organised by the bank on event-driven investing that M&A activity tended to lag the broader stock market by a year, meaning Europe was now primed for a fit of takeover activity. The bank’s hedge fund investor survey, which polled over 500 respondents representing $1.16tn in hedge fund assets, showed demand from investors for event-driven strategies almost doubled from the year before. Mr Scaramucci says: “I think we’re in the first or second inning in this trade, and I predict we’ll have more money to allocate to these strategies in the future.”