After several years of tepid interest, event-driven hedge fund strategies are back in fashion as investors rush to capitalize on the boom in mergers and acquisitions. Event-driven funds received $9.65 billion in net inflows in March, more than any other strategy, according to suburban Atlanta–based data provider eVestment.
Event-driven investing involves making a return from predicting corporate events that will affect the stock price of a particular company. This includes mergers, acquisitions and share buybacks.
The recent rush of inflows into event-driven funds reflects a sense among investors that the renaissance in M&A is more than a passing fad. “We started to allocate to event-driven strategies in the fourth quarter of 2013 because companies were sitting on record levels of cash, much of which we felt would be used for acquisitions,” says Arnaud Gandon, chief investment officer at Heptagon Capital, an $8.4 billion investment management firm based in London.
Figures from eVestment show a 6.3 percent return among hedge funds using event-driven strategies for the six-month period ended March 31. This is the greatest return from any hedge fund strategy except for that of distressed assets, which itself often relies on event-driven investments.
This latest M&A boom was put into motion by corporate cash stored up during the recession. “Between 2008 and 2013 the focus of CEOs was to mend their balance sheets and pay dividends — creating a lot of cash for their companies until they felt comfortable with the global economic environment,” says Nicolas Campiche, Geneva-based CEO of $14.7 billion Pictet Alternative Investments, part of the Pictet banking and asset management group, which as of September 30 had $433 billion in assets under management. “We’re now at the juncture where M&A activity is rising because CEO confidence is rising.”
Global volume for M&A deals launched in the first four months of the year totaled $1.3 trillion, one of the heaviest quarters since 1998. Recent big M&A events include the U.S. pharmaceutical giant Pfizer’s ongoing moves to take over U.K.-Swedish pharmaceutical company AstraZeneca, General Electric Co.’s $16.9 billion offer for French company Alstom’s energy business and Comcast’s $45.2 billion bid for Time Warner Cable.
Interest in event-driven has also grown in part because of the relative unattractiveness of other hedge fund strategies. “In this current market, event-driven is clearly better than credit strategies, equity long-short and global macro,” says Troy Gayeski, partner and senior portfolio manager at SkyBridge Capital, a New York–based fund-of-hedge-funds firm with $10.5 billion under management.
Credit strategies tend to produce lower gains when yields in the underlying market are relatively low, as they are now. When it comes to equity long-short, Gayeski cites the increase in correlations among individual equities because of aggressive central bank monetary policy. In the case of global macro, he blames the absence of explosive events, which send markets rising and falling sharply, and the long-term trend for different asset markets to become more correlated with one another. The latter makes it hard for macro managers to take bets on one and against another. Also, event-driven strategies generally have a high correlation with stock markets.
Is the high correlation a virtue or a vice? Gayeski says it does not make event-driven strategies attractive on their own, but it is a “secondary attraction” for those investors who predict further stock market rises in response to the improving global economy. “In terms of upside capture, event-driven is at the top,” he says, “providing more upside in strong equity markets than any other hedge fund strategy.”
Some investors are keen to reduce the beta (stock market volatility) in their portfolios, while accepting that it cannot be eliminated entirely. Gandon of Heptagon says event-driven managers help do that. Investors say that merger arbitrage, by which investors buy the shares of the company being acquired and short the shares of the acquirer to capture the difference between the present and final prices, does not produce sufficiently high returns. Skeptics note that in the present environment it is difficult to achieve returns on this of more than 6 percent. Instead, investors in hedge fund strategies prefer managers who seek higher returns by anticipating likely M&A by going long in a stock that is likely to be an M&A target and shorting another company in the same sector that is unlikely to garner the same attention. By doing this, they achieve a relatively modest beta, of 0.3 or 0.4.
Event-driven strategies do hold positive virtues, that is, if managers can win the guessing game of in which sector the next mergers are likely to be. Event-driven investors mention pharmaceutical and telecom as two areas of further consolidation in the coming months.
One characteristic of event-driven strategies that isn’t easy to mitigate is their correlation to the business cycle. They usually do better during times when high levels of corporate cash and confidence generate significant levels of M&A. The key question for institutional investors is, therefore, How long the current good times will last?
Looking back at recent decades, Gayeski estimates that most M&A cycles last 18 months to three years and that the present cycle began in January. That leaves, he says, at the very least more than a year of opportunity for event-driven strategies based on M&A.
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