Event-driven investing has long evoked the image of the suspender-clad 1980s corporate raider hunting for undervalued, management-heavy companies and, more recently, has been epitomized by activist investors, many of whom have abandoned the strategy after several famously difficult years. The latter group, in particular, have fueled a fair amount of misunderstanding about event-driven investing, its implementation and its appropriate place in an investors’ portfolio. But the landscape for event-driven investing has changed dramatically over the last three years as the number of managers has declined at the same time the environment has become favorable again for capturing value from corporate actions.
Event-driven investing is a highly sophisticated and nuanced strategy. By definition, event-driven investments are primarily dependent on the outcome of specific, catalyst-focused, corporate “events,” including mergers, acquisitions, bankruptcies, tender offers and other types of restructurings and may have a lower correlation to overall market performance.
Each “event” investment tends to trade on specific deal dynamics and is generally not correlated to other events in the portfolio. In other words, the outcome of a single “event” does not typically affect the outcome of other portfolio investments.
The primary risk in event-driven investing is individual transaction risk, should a planned corporate event not occur. If a deal is terminated, the target and acquiring companies’ securities tend to revert to price levels prior to the transaction announcement, possibly erasing gains or causing losses.
The Changing Landscape for Event-Driven Investing
The event-driven investment landscape has had its ups and downs over the past three years. With abnormal deal and broader event activity seen across 2015 and 2016, many “events” failed to materialize for investors. In total, event-driven hedge funds lost $38.3 billion in net assets in 2016, according to data tracker HFR. A total of 37 event-driven hedge funds closed in 2016 according to data from Eurekahedge, with the HFRI ED Merger Arbitrage Index gaining 1.6% as of September 2016, less than half the 3.5% advance in the HFRI Fund Weighted Composite Index. As a result, many large hedge funds exited the business and other “celebrity” investors have been humbled as well. The result is fewer dollars competing for deals.
Yet so far in 2017, we are already experiencing a return to historical norms and a landscape flush with opportunity for the remainder of the year. The total number of global M&A deals announced fell by 17.9% versus the first quarter of 2016, yet overall deal value was up by 8.9% to a total of $678.5 billion. A variety of factors are behind this including:
- Strong equity markets
- Good reserves of cash on balance sheets
- Access to relatively cheap debt
- Strategic M&A continues to be seen as the best way to add value in a low growth environment
In addition, the regulatory environment may be somewhat more favorable now than it has been in the recent past. While the Trump administration’s policies toward antitrust enforcement are not completely clear yet, we expect to see a less restrictive environment in the near future. Moreover, high expectations for a corporate-tax overhaul helped to extend a stock market rally after Trump’s November election win. His victory also fueled speculation that a widely talked about measure that would encourage firms to repatriate cash held overseas would accelerate the pace of mergers as firms, particularly in the technology sector, looked for ways to spend that newly liberated cash.
The Case for 50/30/20
Similarly, the case for including an allocation to event-driven investing has changed as well. For many years, a 60/40 portfolio (60% equities, 40% bonds or similar fixed income securities) performed well. But several bear markets exposed limitations of the strategy to continue to produce strong returns. A growing body of research has many experts from the industry now advocating for a 50/30/20 portfolio, 50% equities, 30% fixed income and 20% liquid alternatives.