Event Drive Hedge Fund Strategies

Event-driven hedge fund is an ambiguous “bucket” term, describing sophisticated investment vehicles that employ a tactical allocation to several different strategies including various arbitrage approaches and distressed investing. The multi-strategy approach is used in order to capitalize on a range of situations where corporate activity or catalytic change is occurring. It is arguable that no time in history can lay claim to such a dramatic economic environment as the one which persists today. Investors hesitant to follow the herd mentality of investing in short-term trading-oriented funds have found similar agility—although with less liquidity—in event-driven opportunities. Throughout the third quarter, investors gravitated towards event-driven funds, primarily in the merger arbitrage and distressed fixed-income areas. This was due in large part to the numerous opportunities created by the economic environment.

click to enlarge

BHA statistics show that a little more than 37 percent of investors profiled during the third quarter expressed an interest in either event-driven, merger arbitrage, or special situation strategies. Multi-strategy approaches within event driven have historically favored a substantial weighting to merger arbitrage. 2008 was an extremely difficult year for all investors, but even more so for those looking to profit on mergers and acquisitions. The continuously dwindling credit markets, coupled with companies’ own financial troubles, have made life very challenging for dealmakers.

The explosion in worldwide equity markets during the first three quarters of 2009, along with successful capital raising campaigns by large financial institutions, created a much more favorable environment for catalyst events. Dealogic, a global provider of technologically advanced software, communications, and analytical products, reported a total of 140 distressed-debt M&A transactions as of August, which surpasses the 102 that took place in all of 2008.[1] Much of the early corporate M&A activity was due to the fiscal crisis—a firm’s survival was usually at stake—and was concentrated in the biotechnology and pharmaceutical industries.

However, the recent announcements of acquisitions by well-know companies such as Xerox (XRX), Walt Disney Corporation (DIS), and Kraft Foods (KFT) are examples of the flurry of corporate activity in a variety of sectors, offering highly-skilled managers ample opportunities. A fund manager’s skill is inexplicably tied to the performance of every hedge fund strategy; however, event-driven funds specializing in merger/risk arbitrage heighten this factor exponentially, as specific industry and company knowledge can result in profiting on both successful and unsuccessful mergers. Referring to Xerox and its acquisition of Affiliated Computer Services, Peter Falvey, a Managing Director at Boston-based Revolution Partners, stated that he believes it will “…take a Herculean effort to integrate these two companies.” [2] A portfolio manager at a Zurich-based wealth advisory firm believes that highly-skilled managers able to successfully play off the spreads of merging companies using limited leverage have the opportunity to produce enormously profitable and—even more important—exceedingly uncorrelated returns.

Many event-driven funds have capitalized on the vast opportunities in the distressed fixed-income space, particularly given the enormous spreads on various government and corporate bonds. The spreads on these investments hit historic highs in late 2008, and although they have contracted considerably in the first three quarters of 2009, investment managers have been able to profit substantially on the re-emergence of major financial institutions—specifically AIG, Bank of America (BAC), and Wells Fargo (WFC). The latter, largely considered one of the more stable banks after acquiring Wachovia earlier in the year, recently announced the sale of five-year senior notes, expecting to raise $2 billion. The bonds were launched at 145 basis points above comparable U.S. Treasuries.

Although questions still loom over the strength of large banks’ balance sheets, investors have showed little hesitation in snatching up positions at discounted rates. Dealogic reported that banks and financial institutions have sold more than $11 billion in non-government guaranteed bonds in September alone, an increase of more than $6 billion over August.[3] A senior investment analyst at a southern U.S. university with approximately 30 percent of its endowment dedicated to alternative investments expressed substantial interest in distressed corporate credit and senior bank loans. The school is looking primarily at opportunities within the U.S., and has recently been discussing making slightly less-concentrated subscription commitments.

As markets continue to stabilize, event-driven strategies present considerable options for attractive returns. York Capital Management, a New York-based firm with over $9 billion under management, recently partnered with Bank of America Merrill Lynch to launch a UCITS III-compliant event-driven fund. Attempting to strike while the iron was hot, the fund has reportedly raised assets of $100 million from various investors.[4] Furthermore, M&A activity, particularly in the biotech and pharmaceutical sectors, is set for a takeoff. Research and Markets, a leading source for international market research, has reported that the pharmaceutical industry’s largest players are all facing the expiry of patents on brands that are scheduled to generate annual revenues in excess of $130 billion during the next five years. As a result, pharmaceutical companies’ pipelines are being replenished by the acquisition of biotech firm assets.

These revelations come as no surprise to some of the world’s most sophisticated investors who are always seeking new and innovative methods of achieving superior risk-adjusted returns in all economic conditions.

---

[1] Credit Suisse Tremont Index, “Credit Suisse Liquid Alternatives Month Hedge Fund Commentary,” September 2009, www.hedgeindex.com/hedgeindex/documents/....

[2] Bloomberg, “Xerox to Buy Affiliated Computer in Its Biggest Deal,” September 28, 2009, www.bloomberg.com/apps/news?pid=20601087....

[3] The Wall Street Journal, “3^rd Update: Wells Fargo Offers 5Y Sr Bonds Of $1B-$2B – Source,” September 24, 2009, online.wsj.com/article/BT-CO-20090924-71....

[4] Newstin, “York Capital Management and Bank of America Merrill Lynch Launch York Event-Driven UCITS Fund,” Newswire Today, September 28, 2009, www.newstin.co.uk/tag/uk/147489275.