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Research

Merger Arbitrage flexes its muscles

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Merger Arbitrage has proven to be the most resilient hedge fund strategy throughout the recent market sell-off. The ability of the strategy to protect capital through bad times is something we have underlined in the past and which is bolstered by historical evidence. This is part of the reason why we have been and remain highly constructive on the strategy (at Overweight). Since February 18th, the equity market peak, Merger Arbitrage is down -0.4%, while a 50/50 portfolio of equities and bonds is down -4.6% (based on an MSCI World and Barclays Global Aggregate Bond Index through March 3rd). The strategy was resilient in a context where deal spreads were stable through February 28th, before widening afterward.

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Merger Arbitrage flexes its muscles
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Concurrently, cash levels in portfolios were elevated in early 2020. Seasonal factors, along with the tightness of deal spreads and the completion of several transactions in Q4 all contributed to the elevated cash levels of Merger Arbitrage strategies prior to the selloff. Thus, the recent widening of deal spreads opened opportunities for deploying capital in high conviction deals, i.e. those with an attractive risk/reward profile. Gross spreads on friendly deals have gone from 1% to between 2 and 3% in recent days. Managers started to deploy capital in a number of deals that they have already been invested in, such as Allergan vs. Abbvie and Tiffany vs. LVMH, to name a few. Managers also deployed capital in recently announced transactions such as HP vs. Xerox, E*TRADE vs. Morgan Stanley and UBI vs. Intesa. For some managers, we have seen gross exposures climbing significantly, from 60-70% to 90-100% of net assets.

Outside Merger Arbitrage, it is important to highlight the fact that L/S Credit and EM Macro strategies have also been resilient since Feb 18th (-0.6% and -1%, respectively). Our stance remains at Overweight on both strategies. On a negative note, CTA and Directional L/S Equity strategies underperformed during the same period (-3.6% and -3.2%, respectively). Our stance remains at Neutral on CTA and Underweight on Directional L/S Equity. Yet, within these strategies, dispersion is elevated. The top-performing CTA and Directional L/S within our samples still managed to post positive returns during this troubled period.

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