The great hedge fund rebound from ‘M&A arb-ageddon’
Event-focused investors bet on further jump in corporate deals and restructurings in 2021
Many hedge funds that bet on corporate events such as takeovers were left reeling last March after an “M&A arb-ageddon”, when a wave of deals fell apart or threatened to.
That nightmare month is a distant memory for so-called event-driven funds that are licking their lips at the opportunities they see to bet on corporate deals and restructurings this year.
Such funds lost 12.4 per cent in March 2020, according to data group HFR, their biggest-ever monthly loss, as the coronavirus-driven market sell-off hit many of the deals they were wagering would go through smoothly. As share prices fell, funds with tight stop-losses were forced to cut their positions, leading to further losses.
But the intervening year has been much kinder to event-driven funds. Managers who stuck with their bets on deals made back losses as markets rebounded. The rally in cheap, beaten-down stocks since November’s positive news on the coronavirus vaccine and US stimulus packages is lifting many of the sectors they tend to invest in. And some have also profited from the boom in Spacs, blank cheque companies seeking deals into which many funds have poured money.
Managers are looking at a healthy pipeline of M&A deals and a possible wave of restructurings of companies in sectors such as travel and leisure, which are desperate for lockdowns to be lifted before their cash runs out. Tiny hedge fund Bluebell Capital’s big role in the recent ousting of Danone’s chief executive could also point to attractive opportunities for activist funds.
“Event funds like events. The more activity there is the better, and the greater likelihood more things will be mispriced,” said Luke Lynch, founder of London-based Aslan House, an event-driven hedge fund.
Paul Singer’s Elliott Management told investors this year that event arbitrage and activist bets had contributed to its gains in 2020 and offered further opportunities to make money this year. “There looks to be no diminution of the number, and quality, of potential opportunities in these areas,” the firm wrote in a letter seen by the Financial Times.
Event-driven funds, which account for just over a quarter of the $3.6tn hedge fund industry, gained 28 per cent from the start of April to the end of last year, and are already up 6.5 per cent in the first two months of this year, according to HFR.
Dealmaking ground to a halt early last year, as the Covid-19 crisis shifted executives’ focus away from M&A and towards saving their own businesses. But the rebound has been dramatic — $2.3tn of last year’s $3.6tn of deals were struck in the second half, according to Refinitiv, helped by rising equity markets and cash hoarded by companies during the pandemic.
The trade for event-driven funds is typically fairly simple. Managers buy shares in the target company and bet on a falling share of the acquirer, wagering that they will profit as the spread on the deal closes.
What can make such trades more interesting is what managers call “hair” on a deal — complexity such as the structure of the deal or tough regulatory hurdles that take time to analyse.
Providing a thick carpet of that hair have been worries over who new US President Joe Biden will appoint in important antitrust roles and fears that chilly US-China relations will lead Beijing to fail to approve another deal, as it did with Qualcomm’s merger with NXP in 2018.
Managers often welcome such uncertainty, though, because they believe they can gain an edge, for instance by doing in-depth research on deals or analysing the candidates likely to be appointed by Biden’s administration. A perception that deals will be too hard to analyse can also deter some investors, creating more opportunities for the hedge funds.
“It’s the perception of hair, rather than hair itself” that is keeping some investors away, said Jamie Sherman, portfolio manager at event-driven fund Kite Lake Capital Management. “The regulatory environment on the face of it looks the most threatening it’s been for a while, and from the outside transactions look complicated.”
One sour note for event-driven funds has been the sell-off in Spacs in recent weeks. The eventual downside from investing in these companies may be limited because, under the way Spacs are structured, investors can choose to take their money back eventually. However, Spacs could still sink to sizeable discounts during a sell-off in the meantime. Managers should make sure a “Spac-mageddon” does not ruin what could be a lucrative year.