Event driven investing can mean different things to different people. Investing in opportunities that arise around corporate events and corporate change would be the broadest definition, however there are a whole host of sub-strategies that one should be aware of when considering an allocation.
Hedge Fund Research actually publish indices on 6 separate sub-categories: Activist, Credit Arbitrage, Distressed/Restructuring, Merger Arbitrage, Multi-Strategy and Special Situations. This exemplifies the wide-ranging nature of the strategy and highlights the key top-down choice one needs to make when selecting an event driven strategy.
At Redington we recently completed a manager selection process in event driven investing. Our client base doesn’t tend to make multiple investments in relatively niche strategies. Therefore we surmised selecting managers with broader skillsets and associated increased diversification properties would be the sensible top-down choice.
But what do the numbers say?
Two important quantitative risk metrics we play close attention to at Redington are historical maximum drawdowns and beta to equity markets. By using Hedge Fund Research’s indices we found some interesting results:
The numbers show that the majority of event driven sub-strategies have exhibited meaningful beta to equities since comparative data has been available. In addition, the maximum drawdown over the last 10 ½ years has been greater than 20% for all sub-strategies bar merger arbitrage. This certainly challenged our original hypothesis.
Merger Arbitrage – a no-brainer?
Merger arbitrage is a significant component of many broader event driven strategies – with managers looking to exploit a reasonably reliable risk premia. What is interesting about the above figures (and further evidenced by both HFR’s full track record of merger arbitrage and event driven strategies as well as our own independent analysis), is that blending other sub-strategies with merger arbitrage does not appear to dampen either equity or drawdown risk. Any thought that broader strategies could provide additional protection in equity market sell-offs started to dissipate.
Where did we decide to focus?
A broader event driven strategy can provide more opportunities when the M&A environment is potentially not so ripe. However, what remains attractive about merger arbitrage is that the specific risk being targeted is idiosyncratic and simply emanates from the eventuality that a deal breaks. As the typical transaction is completed in a few months a merger arbitrage portfolio is constantly self-liquidating, allowing managers to quickly adjust to the investment climate and further reduce unwanted equity market risk.
So, both our quantitative and qualitative work has led us to conclude that for investors looking for a smoother ride over a market cycle, allocating to a manager focused on merger arbitrage can be the most attractive proposition.