Risky Business for Arbitrageurs as Megamerger Deals Collapse – October 2014

by Samuel McKenzie

  • 31 Oct 2014
  • HF

Preqin’s Hedge Fund Analyst tracks 489 hedge funds that utilize risk/merger arbitrage in their strategy, with 124 of these funds citing risk/merger arbitrage as their core strategy. Risk/merger arbitrage funds have been in the spotlight more than usual recently as a number of high-profile deals collapsed this year. As announcements are made in the public domain, these funds’ investment activities tend to be widely known, as they seek to generate absolute returns from this type of corporate activity. Moreover, some of the most prominent arbitrageurs (John Paulson’s Paulson & Co.) are among the biggest hedge fund managers in the world, adding to the media interest surrounding the strategy.

This year has not been the best period for risk/merger arbitrage funds, as the collapse of a number of ‘megamergers’ over recent months has left a stain on their otherwise consistent performance record. In May 2014, the $116bn bid for British pharmaceuticals company AstraZeneca by Pfizer fell through after talks collapsed; at the start of August, both the Fox/Time Warner and Sprint/T-Mobile deals were also abandoned, with the value in these arbitrage positions remaining ultimately untapped. In the last week, Chicago-based pharmaceutical group AbbVie officially announced the termination of a takeover bid (reportedly worth $55bn) for UK drugmaker Shire, dragging performance down even further. With the collapse of such huge deals, it is no wonder that merger arbitrageurs have taken a hit.

Preqin’s Hedge Fund Analyst shows that risk/merger arbitrage hedge funds have performed fairly consistently over the past few years, delivering annual returns between 4% and 7% since 2010. As a result, the five-year volatility of these funds has been relatively low (2.63%) compared to other event driven strategies (6.12%) and the overall hedge fund benchmark (5.19%). However, the benchmark generated a loss of 0.98% for September 2014 YTD as the collapse of these ‘megamergers’ affected the performance of some risk/merger arbitrage funds. The worst may be yet to come in terms of performance, as the impact of the AbbVie/Shire deal collapsing will not be known until the end of this month.

It is not all bad news for the strategy, however. Preqin’s Hedge Fund Investor Profiles tracks 831 hedge fund investors with a preference for risk/merger arbitrage, suggesting that there is an appetite for funds to profit from corporate mergers and acquisitions despite the risks involved in this complex and sophisticated strategy, as 2014 has shown.

Nevertheless, as we approach the end of the year, there is still time for these funds to make a comeback and recoup the losses made in the summer of 2014.Yet this might prove difficult for merger arbitrageurs, as opportunities such as these ‘megamergers’ may not appear again. However, there is good news for the strategy as Preqin has reported that a number of hedge fund investors currently have an interest in the strategy, and that these funds have delivered consistent gains over recent years.

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