Market concerns over the economic impact of rising Covid-19 infections in the U.S. remain vivid. Yet, the MSCI World is on track to end July in positive territory, up +3.5% month-to-date as we go to press. In our view, the environment remains challenging, and finding assets to diversify portfolios is an issue as Treasury yields are close to record lows.
Merger Arbitrage is typically an attractive alternative strategy to diversify portfolios. Its equity market beta is low, and volatility in returns is also contained. Our stance on the strategy remains constructive (Overweight) despite the recent dry up of M&A volumes in Q2. However, we note that the environment for Merger Arbitrage strategies has improved.
U.S. M&A volumes have started to take off in June and more recently, there has been a flurry of relevant deal announcements for Merger Arbitrageurs. They took place in sectors such as Energy (Chevron vs. Noble), Communication Services (Adevinta ASA vs. Classifieds Business/ Ebay), Industrials (Alpha Laval vs. Neles), and Information Technology (ADI vs. Maxim Integrated Products). Some complex deals in disrupted industries also reached completion, such as the $17.3 bn buyout of Caesars Entertainment by Eldorado Resorts. In parallel, there has been renewed interest for SPACs (Special Purpose Acquisition Companies) in a context where liquidity is king and opportunities to deploy capital were constrained by M&A activity. A special purpose acquisition company is an entity that's set up specifically to make an acquisition of an existing business. They have grown in popularity this year, having raised more than $12 bn so far this year according to Dealogic, close to 2019′s record total of $13.5 bn.
Overall, deal spreads have tightened over the course of July towards 4% across a subset of deals, though they remain wide for few risky transactions where implied odds of completion are weak or have been going through litigation. Against this backdrop, pure Merger Arbitrage strategies tend to maintain a cautious positioning.