A variety of factors have held back returns from event driven strategies since the 2008 financial crisis. We believe that the underlying forces which determine corporate merger and arbitrage (M&A) activity are beginning to align very well and the consequences of a return of enthusiasm will boost the performance of such strategies.
Cerno Capital is allocating 8% of portfolio assets to global specialists who invest around announced corporate events and acquisitions.
Event driven investing encompasses a variety of strategies that all have one theme in common: organisational change. This can be in form of special situations, such as spin-offs, breakups and industry consolidations; arbitrage, evoked by mergers, exchange and tender offers to name some examples; and distressed situations such as bankruptcies, liquidations and restructurings. An event driven manager considers the fundamentals of businesses and industries to anticipate, provoke and take advantage of such situations by investing across the whole capital structure. Position size tends to hinge on a probability based analysis of various pay-offs under all possible scenarios.
As an investing strategy, merger arbitrage performs best within expanding economies with healthy corporate activity. Since 2008, global corporations have delivered and accumulated great amounts of cash on their balance sheets. Despite this, corporate activity has been relatively mute. No doubt this was partly caused by residual distrust of the US economic recovery, combined with out and out scepticism toward European fundamentals and solvency. The equity rally of last year has helped engender greater belief in economic recovery.
In the lower growth world in which we live, organic growth will be harder to achieve. This will drive corporates to look for other types of growth through identifying synergies and economies of scale, or simply buying revenue streams. Therefore, we expect that many such acquisitions, restructurings, consolidations that have been on boards’ agendas for the past few years, will now materialise, at progressively higher prices.
M&A activity has already begun to pick up in some key sectors, notably healthcare, media and telecoms. Seven US$10bn+ M&A deals were announced in the global telecom sector in 2013 which compares to just one deal in 2012, 2013 representing the highest level of activity since 2005 according to Dealogic.
For event driven funds, increased activity means a broader opportunity set and potentially increased returns. A higher quantum of deals will tend to widen spreads, as will higher interest rates. Furthermore, the complexity of transactions will rise with a higher deal count, which can present more asymmetric pay-off profiles as only the most skilled managers will be able to take advantage of these opportunities.
We believe we have identified those capable managers, who have the skill-set to assess the most complex deals and the experience to identify opportunities across the whole capital structure to deliver attractive absolute returns.