Tag Archives: portfolio-strategy

The Season For Merger Arbitrage

Summary The ongoing boom in M&A activity is creating a more robust opportunity set in merger arbitrage. Importantly, this is occurring at the same time that most other strategies (and general equity market exposure) are becoming increasing overvalued/unattractive. From a risk standpoint, merger arbitrage also appears to be becoming more compelling given its relatively low beta, and the plethora of risks building for general equity market exposure. A Little Background For those new to the strategy, generally when a merger is announced, the stock price of the target immediately jumps toward (but not fully to) the offer price. The remaining gap exists for two primary reasons: 1) there is a possibility (typically small) that the deal could fail to be consummated, and 2) legacy holders of the target’s stock that have typically just experienced a large windfall gain are sometimes willing to forgo the relatively smaller amount of remaining alpha due to their lack of experience in merger arb (and consequent limited ability to underwrite the risks). Merger arbitrage specialists attempt to capture this alpha by buying the target’s stock (and shorting the acquirer’s in cases where part of the consideration offered is stock). They then seek to profit as the spread compresses, with the deal moving to completion. Merger arb is most commonly pursued by hedge funds. However, in recent years ETFs have also emerged to pursue the strategy passively (the largest of which being the IQ Merger Arbitrage ETF (NYSEARCA: MNA )), and there are a handful of Seeking Alpha contributors focusing on it as well. Increasingly Attractive when Other Strategies are Least Attractive Like most strategies, the general attractiveness of merger arb varies over time based on fluctuations in supply (in this case of M&A deal volume) and demand. As mentioned, demand comes mostly from hedge funds and tends to be reasonably sticky, as it takes time for the funds to raise capital from their underlying investors (or for investors to take back capital) based on changes in the attractiveness of the opportunity set. The result is that when there are big changes in deal volume, this supply can temporarily overwhelm (or underwhelm) demand, leading to higher (or lower) risk-adjusted returns. From 2010 through 2013, deal-flow was limited as corporate managements were reluctant to make bold moves toward expansion with fresh memories of the 2008-2009 disaster in mind. As a result, merger arb players struggled to perform, and the HFR merger arb index posted very modest single-digit returns annually. However, since 2014 there has been a substantial pick-up in M&A activity as the financial crisis has fallen farther from mind, many corporate balance sheets have become increasingly bloated with cash, and tightened credit spreads have enabled companies to raise capital very cheaply. (click to enlarge) Source: Dealogic Though many hedge funds have been seeking to deploy additional capital in the space, demand has still been slow to catch up with supply. The result is that merger arb has been becoming more interesting at the same time that most other strategies and equity beta have become less attractive. One illustrative data point is that the number of $100m+ deals with annualized spreads over 15% ballooned from late 2014 to now, as shown below. Source: SINLetter Less Beta when Beta is Most Overvalued In the current environment with high equity valuations and abundant macro dangers, another potential attraction of merger arb is its risk profile, as noted above. For each deal, the main sources of risk are idiosyncratic/company-specific (e.g., antitrust investigations, unwieldy regulatory reviews, loss of financing). It is true that merger arb still retains some exposure to general risk premiums, or the tendency of market participants to require higher returns to hold any investments during times of fear. Further, the probability of deals breaking does increase somewhat when market is stressed, particularly for deals with financing contingencies (e.g., LBOs). However, the recent M&A boom has predominately represented strategic deals with relatively few LBOs. Also, the level of exposure to general risk premiums is lessened due to the short duration, self-realizing nature of the strategy. Accordingly, the strategy has tended to produce much lower drawdowns than the overall equity market during past market shocks. For instance, in 2008-2009, the CSFB risk arbitrage index posted a maximum drawdown of roughly 20% vs. roughly 50% for the S&P 500. In 2000-2001, the risk arb index posted a max drawdown under 10% vs. ~40% for the S&P 500. Conclusion For those with interest/experience in event-driven investing, this is a good time in the cycle to explore opportunities in merger arb. For those with less experience or time to underwrite the risks of individual deals, a diversified approach may be worthy of consideration, for instance through one of the ETFs that exist today. Disclosure: I am/we are long DTV, MEA, OVTI, OWW, DARA, PNK, ODP. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Loan Fund Primer

Sweden is now the latest country to make headlines about extreme central bank policy to stimulate growth which creates a dilemma for Swedish people trying to save money. This highlights the need to learn about different sectors of the fixed income market and taking a multi-sector approach in your fixed income portfolio. One sector that has attracted attention and assets has been the loan market. By Roger Nusbaum, AdvisorShares Strategist Last week the Riksbank (the Swedish central bank) dropped its benchmark interest rate to -0.10 and as of earlier this week Sweden’s ten year sovereign debt was yielding 0.50%. So Sweden is now the latest country to make headlines about extreme central bank policy to stimulate growth. We will see whether this turns out to be effective policy but it creates a dilemma for Swedish people trying to save money. This is the same or similar dilemma for people in many other countries including the US and while our rates are not as low as many other countries they are low enough to be problematic; two basis points for a money market and 2% for ten year treasuries. We’ve been looking at this issue for years, making the point about the need to learn about different sectors of the fixed income market and taking a multi-sector approach in your fixed income portfolio. We’ve talked about combining sectors with higher yields and so potentially more risk with sectors with lower yields and likely less risk to get an overall yield that hopefully approaches a useful level even if not a normal level; normal based on historical interest rates. One sector that has attracted attention and assets has been the loan market. There have been traditional mutual funds offering access for a fair bit of time and in the last couple of years ETFs have been rolled out that target the sector and the asset flows have been huge, more than $5 billion for the largest fund in the group. The attraction is simple enough; yields can be in the four percent range and because of their reset feature they don’t take interest rate risk. ‘Reset feature’ means that the interest rate paid on the loans adjusts based on prevailing rates on a regular interval, usually every three months. If you look on the info page for a loan fund you’ll see a maturity of several years but you’ll also see something like average days until reset which is when the rate on a given loan will update. From quarter to quarter there may not be much change but occasionally there will. This entire mechanism reduces interest rate risk to being essentially a non-issue. The credit quality of course tends to be lower which accounts for the yields being relatively attractive. Credit risk is generally mitigated, but not completely mitigated, by accessing the space via a fund similar to high yield. I would note that accessing an individual loan is not really a possibility for individuals. The other risk to mention is liquidity risk. Loans don’t trade on a secondary market so during some sort of event that strains liquidity the funds and their holders could have a problem with short term volatility. Most of the funds have the flexibility to hold some bonds that do trade on a secondary market to help in the face of a liquidity event. Anyone interested in the space, and with the yields available it is worth learning about, should take the time to understand what their given fund will do to address this potential issue. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article. Additional disclosure: To the extent that this content includes references to securities, those references do not constitute an offer or solicitation to buy, sell or hold such security. AdvisorShares is a sponsor of actively managed exchange-traded funds (ETFs) and holds positions in all of its ETFs. This document should not be considered investment advice and the information contain within should not be relied upon in assessing whether or not to invest in any products mentioned. Investment in securities carries a high degree of risk which may result in investors losing all of their invested capital. Please keep in mind that a company’s past financial performance, including the performance of its share price, does not guarantee future results. To learn more about the risks with actively managed ETFs visit our website AdvisorShares.com .AdvisorShares is an SEC registered RIA, which advises to actively managed exchange traded funds (Active ETFs). The article has been written by Roger Nusbaum, AdvisorShares ETF Strategist. We are not receiving compensation for this article, and have no business relationship with any company whose stock is mentioned in this article.

Alternate Current: The Power Of Diverse Return Sources

By Christine Johnson After a long period of calm, global markets now face tumbling oil prices, geopolitical risks and monetary policy changes. Investors looking for new ways to diversify in this uncertain environment should take a long look at investments that don’t take their cues from stock or bond market movements. The Key: Un-Stock-Like Return Patterns Alternative investments have that name for a reason: they don’t act like traditional investments. Adding alternatives thoughtfully to a portfolio may lower its sensitivity to the stock market and interest-rate fluctuations. Alternatives also have the potential to enhance long-term returns and reduce risk. Investors may be surprised to learn that over the last 25 years, alternatives have produced higher returns than stocks, bonds or cash – with less than half the volatility of stocks (Display). A big part of the equation? Managers’ use of flexible investment approaches, and their ability to act opportunistically to exploit mispricings within and across asset classes. How Do Alternatives Handle Stress? On average, alternative investments haven’t been up as much as stocks in bull markets, but they also haven’t been down as much as stocks in bear markets. By losing less than traditional equity strategies during times of market stress, alternative strategies have historically preserved investors’ capital. In 2001 and 2002, as markets struggled to recover from the dot-com bust, alternatives provided more downside protection than stocks. In 2008, alternatives also lost less than stocks. Alternatives in the Portfolio Context Investors want more diversification in their portfolios; we think investments that don’t track stock and bond markets as closely as traditional investments offer that potential. Many alternative strategies provide returns driven more by a manager’s skill in decision making than by broad market movements. And there’s a lot of variety among alternatives. Investors can choose narrowly-focused alternative strategies – nontraditional bond or long/short equity, for example. Or they can opt for a more diversified strategy like multi-manager. This offers exposure to diverse approaches – and even diverse managers. A manager’s investing skill is integral to alternative investing, and the returns of individual strategies can vary greatly. A diversified strategy may prove valuable. Challenging market periods turn up unexpectedly, and a diversified investing approach that incorporates alternatives may help portfolios’ performance across diverse market conditions. Not all strategies will be in or out of favor at a given time. This point is particularly relevant in terms of US stocks. The lofty returns of the last couple of years won’t last indefinitely – so it makes sense to look for strategies whose return patterns offer something different from those of the broad market. The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. MSCI makes no express or implied warranties or representations, and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI. Christine Johnson is Managing Director of Alternative Investments at AB (NYSE: AB ).