Event-driven hedge fund managers expect big opportunity — and big profits — in the growing level of merger, acquisition and other corporate activity this year.
“We see great investment opportunities in Europe and North America this year,” Thomas E. Sandell, CEO of Sandell Asset Management Corp., New York, said in an interview with Pensions & Investments during the SALT hedge fund industry conference in Las Vegas earlier this month.
Event-driven hedge fund managers generally are looking for a catalyst in a corporate situation. Those can include mergers and acquisitions internal restructurings, division spinoffs and moves into bankruptcy.
The results of the successful search for such catalysts has been strong performance of event-driven hedge funds, with the HFRI Event-Driven Total index returning 12.5% in the year ended Dec. 31, its best year since 2009, and 1.8% for the quarter ended March 31, the best among the broad strategy categories tracked by industry researcher Hedge Fund Research Inc., which manages the HFRI family of indexes.
While the number of M&A deals globally fell to 38,054 in 2013 from 43,695 in 2012 and 44,636 in 2011, the dollar value of deals rose to $2.9 trillion in 2013 from $2.7 trillion and $2.8 trillion in each of the prior years, data from Dealogic Ltd. show.
“Companies are finding the current environment conducive to making deals,” Terra A. Fuller, senior vice president and head of hedged equity, Mesirow Advanced Strategies Inc., said in an interview from her Chicago office.
The factors shaping an environment prime for event-driven hedge fund profits are a low-growth economy, low financing levels and corporate balance sheets plump with unused cash, she said.
The increased cash value of M&A deals is providing “validation for corporate management teams, encouraging them to take balance sheet cash and use it for M&A, rather than for share buybacks that were more common over the past few years,” Ms. Fuller said.
“We've been finding that event-driven and special-situation hedge fund strategies are a significant source of alpha now,” especially in the U.S. and Europe, said Ms. Fuller.
Mesirow Advanced Strategies manages $13.7 billion in hedge funds-of-funds strategies.
Mr. Sandell and other hedge fund managers specializing in one or all of the major subsets of the event-driven strategy category — activist, distressed/restructuring, merger arbitrage and special situations — agree about strong prospects for alpha generation.
Sandell Asset Management runs about $1 billion, mostly for institutional investors, in three event-driven strategies: credit opportunities; equity special situations; and merger arbitrage.
Mr. Sandell said Sandell's best event-driven opportunities now are in the firm's equity special situation strategy, especially a trend toward non-real estate companies converting into real estate investment trusts as a way to recapitalize. The data management company Iron Mountain Inc., for example, owns its underground data storage facilities, and has applied to become a REIT, Mr. Sandell said.
“There is a tremendous demand for yield in today's environment, with fixed-income trading almost at zero,” Mr. Sandell said. He noted REITs, by contrast, generally are trading at yields between 5% and 6%.
“High demand for yield creates great opportunities for REIT conversions,” he added.
Geographically, “Europe, with its old, fat lazy companies, offers good opportunities for event-driven managers,” Gary Kaminsky, vice chairman of the wealth management business of New York-based Morgan Stanley (MS), said during a SALT panel discussion.
That scenario is manna for European event-driven fund managers like Reade Griffith, chief investment officer of the $560 million event-driven Polygon European Equity Opportunity Fund. The fund is managed by Polygon Global Partners LLP, which runs a total of $1.6 billion, largely for institutional investors.
“Event-driven has been different since 2008, after the financial crash,” Mr. Griffith said in an interview from Polygon's London office.
“After 2009, the U.S. equity market went up and never came down,” Mr. Griffith said, noting the healthier market provided more catalyst possibilities. “U.S. event-driven funds followed — went up and never came down,” he said.
The European equity market, on the other hand, “triple bottomed out” between 2008 and mid-2012, bringing Europe “to its knees,” while event-driven hedge funds dropped to the “absolute bottom. They were the very worst hedge funds. Many funds just closed. There was barely a pulse in this part of the industry,” Mr. Griffith said.
In July 2013, the situation changed dramatically as investor capital began to flow back into European event-driven hedge funds, and companies in the U.K. and on the continent began to attract the attention of acquirers.
“The turnaround in the past 10 months has been amazing. It's like being in a time warp to four years ago in the U.S., when everything began to pick up. There is so much ahead for Europe,” Mr. Griffith said.
“So many interesting things are happening in Europe,” especially the emergence of U.S. companies “crossing the pond to bid on European companies,” such as General Electric Co. and France's Alstom; Mylan Inc.and Sweden's Meda AB; and McKesson Corp. acquiring Germany's Celesio Group, Mr. Griffith said.
The return potential of event-driven hedge fund strategies has pushed hedge funds-of-funds managers, good proxies for institutional investor interest, to move significant portions of their portfolios into event-driven funds.
The portfolio weighting for event-driven strategies in SkyBridge Capital Management II LLC's flagship hedge fund-of-funds strategy has been ratcheted up to the 40% maximum since mid-2013 by Ray Nolte, chief investment officer of the New York-based firm.
“A nice attribute of event-driven/merger arbitrage strategies is that they don't necessarily need equity markets to go up” for the catalyst to take place, Mr. Nolte said in an interview during the SALT conference, which is produced by SkyBridge Capital.
“We like the asymmetrical aspect of the alpha that these hedge fund managers produce,” said Mr. Nolte.
He added that event-driven strategies provide advantages in both modestly up and down equity markets. For example, in the 10% U.S. market that SkyBridge predicts for this year, “we can capture the market move and have a little alpha generation proposition from the event-driven strategies,” Mr. Nolte said.
If 2014 ends up being surprisingly strong, “these managers will capture a lot of that upside through the beta component of their strategies,” he added.
And if 2014's equity market is “modestly negative,” down 5% to 10%, “there's still a good chance that some of the events will work out. So we will lose a little on the market move and make it back with the event move,” Mr. Nolte said.
SkyBridge manages $7.5 billion in hedge funds of funds and separate accounts, and provides hedge fund advisory services for institutional investors with assets totaling $3 billion.
Ms. Fuller said Mesirow Advanced Strategies has increased its weighting to event-driven hedge fund managers in the past 12 to 18 months, but did not provide the size of the allocation. She noted that many of the “opportunistic hedge fund managers we invest in naturally are tapping into all kinds of deals, both pre- and post-merger activity.” n
This article originally appeared in the May 26, 2014 print issue as, "Event-driven strategies are shining this year".