Amid the sound and fury of renewed Covid-19 lockdowns across Europe, global equities took a plunge at the end of October, bringing the MSCI World down -3% for the full month. Bonds did not provide much protection, as fiscal stimulus packages to avoid a major blow to economic activity would put upward pressure on yields.
In the hedge fund space, strategies with a higher market beta such as Special Situations and Directional L/S Equity underperformed (-0.8% and -0.6% resp. in October), while CTAs and Market Neutral L/S also posted negative returns (-1.2% and -0.8%). Merger Arbitrage and L/S Credit managed to post positive returns.
Merger Arb. has benefitted from attractive deal spreads, renewed M&A volumes in the U.S. and from its power of diversification. We estimate its equity market beta at 3% now, below the 5-year average (8%). This implies a 10% fall in the MSCI World would lead to a 0.3% fall in returns. Last month, alpha generation was thus significant.
Reframing Merger Arb. in the current context of U.S. elections, the strategy is not deploying assets based on views on the outcome of it. Cash holdings are elevated at present. Agnosticism vs. the U.S. election also implies that managers are not concerned in the short term about a potential Democratic President and tougher anti-trust regulations. The key theme to watch for Merger Arb. is SPACs and how far they will boost corporate activity. A SPAC (Special Purpose Acquisition Company) is a financing tool that allows investors to co-invest with a sponsor (the acquirer). It is a newly formed public company whose sole purpose is to acquire or merge with an operating business within a fixed time frame. SPACs have been around since the 1980s, but their popularity has flowed since the early 2000s. The SPAC market boomed in 2020 and Mega SPAC IPOs emerged. They have brought increased liquidity to the market and attracted institutional and alternative investors. SPACs are attractive for Merger strategies as they offer an attractive and low volatility return profile. SPACs were strong positive contributors to Merger Arbitrage returns last month. They should ensure robust M&A volumes in the quarters to come, with USD 50bn of unlevered capital available to make acquisitions going forward according to Dealogic as of end-Q3.