Event Driven Strategy Outlook: Looking Beyond Merger Arb
Mar 17, 2014 | By Alex Gavrish, Etalon Investment Research; author of
"Wall Street Back To Basics"
Credit Suisse recently released its Annual Hedge Fund Investor Survey. The survey, produced
by Credit Suisse's Capital Services Group, is one of the most comprehensive in the industry,
with over 500 respondents - including pension funds, endowments, consultants, family offices
and fund of hedge funds - and with respondents diversified across all regions.
One of the key findings of the survey is that interest in event driven strategies reflected the
greatest year-on-year increase in demand, nearly doubling from the prior year. An additional
indication that event driven investment strategy is becoming more and more popular among investors
is the fact that over the past year, traditional mutual fund companies such as Fidelity Investments
introduced mutual funds that employ event driven strategies. Typically used only by hedge funds, the
strategy is being increasingly accepted by a wider audience of investors and managers.
Fuel for events
There are two main reasons event-driven space will provide plenty of opportunities in the coming years.
First, developed economies in general are far from a high-growth mode and many corporations have smaller
growth ambitions than they had few years ago before the credit crisis. With ongoing deleveraging process,
instead of planning for growth there is more and more focus on managing current situation and adapting to
economy conditions. As an illustrative example, businesses that have a lot of free cash on their balance
sheets might choose to use it to repurchase shares instead of investing it into new projects. Consider the
recent case of Polycom, provider of video conferencing solutions: on September 11th, 2013 company announced
share repurchase program in the amount of $400 million dollars, which represented approximately 20% of
Polycom's market capitalization as of the announcement date. Part of the repurchase program was completed
by October 30th, 2013 through Dutch tender offer and on December 04th, 2013 remaining part was announced
to be executed through accelerated share repurchase program. Stock price reacted favorably to this event
and the share price rose 25% over a six months period since announcement of the buyback program back in
September 2013. It is also easy to see the importance of buybacks from the performance of buyback index.
S&P 500 Buyback Index, designed to measure the performance of the top 100 stocks with the highest
buyback ratios in the S&P 500, outperformed S&P 500 Index by 123% over the past 5 years: it provided
a cumulative return of 297% as opposed to a 174% return on the S&P 500. As a result of the focus on
managing current situation, different corporate events surface such as dividend payments, share buybacks,
sales of non-core assets, restructuring initiatives, etc.
Second reason is related to the role institutional and other shareholders play at the companies.
Through some painful lessons of 2008 credit crisis shareholders understood that it is not enough
to passively buy and hold securities but a more proactive approach is required. Agency problem
and other conflicts of interest inherent in a capitalistic free market economy surfaced in full
force through a structure of capital markets. Activist hedge funds, representing the most dynamic
and aggressive segment of the hedge fund and investment management industry embraced this idea.
They responded to shareholder concerns and desire to influence management of companies with a
wave of activist campaigns. This made the battlefield for event-driven funds much more attractive.
Activists create a lot of opportunities to generate alpha either by passively following activist
campaigns or by reacting to corporate events that activism generates, such as spin-offs, M&A
situations, asset sales, recapitalizations and capital structure optimization, dividends,
buybacks and other events. It is reasonable to assume that this trend will continue into
the foreseeable future.
Broader focus required
Event-driven is an investment strategy that seeks to exploit pricing inefficiencies that may occur
before or after a corporate event, such as a merger, spin-off, asset sale or other significant
transaction. Among the most important attractions of the event-driven approach is the ability
to find specific corporate events and target certain returns. A core segment of the event driven
space is a merger arbitrage strategy that provided very attractive risk-adjusted returns in the past.
At present, merger arbitrage spreads are at historical lows and the strategy is essentially dead.
At the same time, other events exist in abundance. With a broader focus, event driven approach
can be combined with a strong emphasis on value investing principles. Such combination can
provide the best of both worlds: it can unite opportunism and bargain hunting with specific,
idiosyncratic corporate events. A broader event-driven strategy is therefore very appealing
in current market environment and can serve as a good long-term approach to portfolio
management and alpha generation.