Event-driven strategies take tumble

Event-driven managers are taking it on the chin, racking up net outflows of $38 billion so far this year, the largest among all hedge fund strategy categories.

In fact, assets redeemed from event-driven funds through Oct. 31 already are double the $19.4 billion of net outflows the category saw from all of 2015 and account for almost half of the $77 billion of industry-wide redemptions year-to-date, data from eVestment LLC show.

At issue: investors' dissatisfaction with the 2015 and 2016 performance of the activist faction within the event-driven segment of the market, sources said.

Managers of more traditional, fundamental event-driven strategies — credit arbitrage, merger arbitrage, special situations and distressed/restructuring — are faring much better in general, reporting relatively stable assets under management, increased interest and investment from asset owners globally.

“Event-driven hedge fund strategies tend to be painted with one big brush, but parts of the industry have been doing well and others have not,” confirmed Raymond C. Nolte, chief investment officer of SkyBridge Capital Management II LLC, New York.

“The bulk of the assets redeemed from event-driven strategies have been from the mega-event managers,” SkyBridge's Mr. Nolte said, noting “activist funds went from feast to famine and this tends to form the narrative for the whole category, which is not really accurate.”

Among the activist managers with large drops in AUM are a handful of well-known firms such as JANA Partners LLC, with a 37% decline in assets to $7.4 billion for the year ended June 30; Pershing Square Capital Management LP, with an AUM drop of 37.4% to $11.6 billion between June 30, 2015 and Oct. 31; and Third Point LLC, with a 10.1% decline to $16 billion between June 30, 2015 and Feb. 29, according to Pensions & Investments' analysis of company-provided and publicly available information.

Representatives from these activist managers declined to comment or did not respond to requests for comment.

The cooling-off period for activist hedge fund managers and fundamental event-driven managers began in early summer 2015: Assets managed in all strategies in the event-driven segment peaked at $588.5 billion on May 31, 2015, and fell 11.9% to $518.4 billion as of Oct. 31, eVestment data show.

Market conditions, crowded investment trades, ready liquidity and an ever-growing number of managers joining the activist camp combined to knock down returns in the event-driven segment, industry observers noted.

“Event-driven strategies tend to underperform during strong market cycles, but activist managers have had an even harder time because most of the low-hanging fruit has already been picked off, the product of the zero-interest-rate environment and high valuations,” said Alex Da Costa, director-hedge fund research and consulting in the Montreal office of consultant Pavilion Advisory Group Ltd.

“In response, activists are moving away from more traditional merger-arbitrage strategies toward creating financial engineering deals that have ended up as spectacular blowups,” Mr. Da Costa added.

With favorable liquidity terms, investors were able to bail out of event-driven managers with disappointing performance.

“Where there have been redemptions, event-driven funds have certainly been feeling it. Their assets ballooned over the past few years, and the space, especially in the U.S., became too crowded. Investors typically don't have to lock up their money in these funds, so as returns leveled off they were an obvious source of capital for many investors,” said an activist fund executive who provided reaction by e-mail on condition of anonymity.

“This applies to many activists as well, particularly those focused on the short-term, event-driven end of activism (where they are) trying to force companies to pay jumbo dividends or put themselves up for sale. This is a pure bull market strategy and when things softened, the funds got hit,” the source added.

Some hedge fund firms offering a hybrid private equity fund structure with longer lockups also are coming under fire.

“Pitchforks are out for event-driven/activist funds that not only have performed poorly recently, but (also) for funds that had longer-locked, more private equity-like mandates but were paid based on short-term returns with no clawback. That's a big part of the problem,” agreed an executive from a multistrategy hedge fund who asked not to be named.

By contrast, more fundamentally oriented, smaller event-driven hedge funds report continued inflows and a swelling pipeline of potential institutional investors. Among such firms is BlackRock Inc., New York.

BlackRock gave Mark McKenna, managing director and global head of event-driven strategies, $100 million in seed capital about a year ago for the launch of a fundamental event-driven fund. The fund has grown to $1.2 billion, mostly through investments from institutions.

“We are as fundamental an investor as you are likely to find. We concentrate on finding hard and soft catalysts in companies and strongly skew away from crowded trades. We are focused on finding uncorrelated investments,” Mr. McKenna said.

Conditions are improving for event-driven managers, Mr. McKenna said, with the market capitalization of companies announcing mergers and acquisitions more than doubling in the last month or so.

BlackRock managed $5.1 trillion as of Sept. 30.

Activist firms with longer investment horizons also are faring well, producing solid returns, retaining AUM and accepting a slow stream of money from new investors, sources said.

Firms such as Cevian Capital II GP Ltd., Trian Fund Management LP and ValueAct Capital Management LP focus on helping companies become more competitive and profitable in a manner very similar to the operational improvements private equity managers use. As with private equity, these managers employ longer-term hybrid lockup structures.

The chief investment officer of an activist fund manager, who asked not to be identified, said in an interview that most redemptions suffered by the firm were from hedge funds of funds, which were being replaced by investments from pension funds and other institutional investors.

SkyBridge, for example, which manages $12 billion in hedge funds of funds and customized hedge fund portfolios, had dedicated two-thirds of its portfolio to activist hedge funds at the beginning of 2016. SkyBridge moved approximately $1 billion from activist hedge funds to other strategies earlier this year (P&I, Feb. 29).The activist allocation now is about 20%, Mr. Nolte said.

Pavilion's Mr. Da Costa said his team “sees a very specific danger in investing with activist managers — hubris. We prefer managers who quietly get out of positions rather than digging their heels in and fighting in public.”