This article appears courtesy of Global Investor
While extreme market volatility during the global financial crisis saw many investors run for cover and seek a safe haven for their capital, it was also a time that had event driven hedge fund managers rubbing their hands in anticipation of the opportunities in front of them.
The event driven strategy involves investments, long or short, in the securities of corporations undergoing significant change. And there have been no shortage of major changes since September 2008.
Such ‘events’ often provide managers with a tangible catalyst by which they may be able to realise the expected change in value in the underlying security. Substantial profits can be generated by managers who correctly analyse the impact of the anticipated corporate event, predict the course of restructuring and take positions accordingly. Two years later, these opportunities are still being presented thick and fast.
In the first quarter of this year the even driven sector posted returns of 4.8%, according to the Credit Suisse Tremont Hedge Fund Index, which were the best results of any type of fund.
“A lot of first quarter returns were pretty impressive in the event driven space,” Paul McCauley, Portfolio Strategist at International Asset Management told Global Investor/isf.
“In the credit area a lot of the Lehman Brothers restructuring as well as other companies was taking place. The hedge funds picked those up at attractive levels and there was an improvement in those throughout 2009 and the start of 2010.”
Second quarter figures were more difficult, the index revealed, with event driven managers finishing up 1.8% as of June. However, that remained respectable during a difficult trading environment and offered significant downside protection.
Although the strategy was the top performer in the first quarter, losses caused by equity market sell-offs in the second quarter negatively affected its overall year-to-date performance.
McCauley added: “In May you had the European issues around Greece, Spain and Portugal and you had a lot of prices dropping 10-15%. So the returns by the end of June have been reeled in a bit.”
The Credit Suisse Tremont Hedge Fund Index stated: “Some of the more recent fluctuations in this sector’s returns are largely attributable to mark-to-market losses and may only affect short term performance.”
More and more private banks are recommending clients allocate money with hedge funds, and in particular event driven funds.
Chris Jones, chief investment officer of Key Asset Management, part of the SEB group, explains why.
“Currently there is an abundance of corporate events, from companies in trouble that have to restructure debt or rearrange their entire capital structure through to companies that seek to grow through acquiring other companies at advantageous valuations,” he told Global Investor/isf.
“This abundance is not expected to diminish for some time. As a result, the opportunity set for event driven investing is favourable. Also, the absolute returns that hedge funds seek to generate look particularly attractive in the unappealing context of equity market uncertainty and low interest rates.”
Yet while distressed markets offer one type of opportunity for fund managers, more positive markets also present opportunities due to M&A activity. And it is the fact that event driven investing can be viewed as a strategy for all seasons that makes it attractive to many people.
Sebastien Fiaux of Credit Suisse said: “There is almost always something to do. When the market is doing well there will be an uptick in acquisitions and corporate activity and when the market goes down, default rates increase which can create distressed investing opportunities. In practicality, the transition period between good and bad can sometimes be painful for event driven managers as everything is correlated.”
Traditionally the US has been the most active market for event driven strategies because of its size but also because of strict procedural rules that have helped to minimise risk compared to other markets.
Fiaux at Credit Suisse said: “The US has always been very conducive to event driven strategies because there are very clear ‘game rules’. Take the bankruptcy code, for example. The US provides ground rules around how a company in default will be re-organised and turned around so there is a recognised framework. That is why distressed investing is much more developed in the US than it is outside the US.
“By contrast, in Europe, there is not one bankruptcy code and therefore, there are fragmented jurisdictions.”
However as emerging markets develop event driven strategies are becoming more and more interested in operating in those areas and there has been a clear spike in activity.
Asia, in particular, has witnessed significant growth and Eurekahedge, a Singapore based fund tracker has said that distressed debt and event driven strategies have been the best performing strategies so far this year returning 8.4% and 5.7% respectively by the end of the first quarter.
“We are seeing an increase in activity in Asia,” Charles Gradante, co-founder of Hennessee Group, an Investment Adviser that consults on asset allocation, manager selection, and ongoing monitoring of hedge funds.
“As Asia Pacific matures it will become more event driven. There are businesses and sectors that are consolidating and there are changes in management and leadership etc. There are a lot of things occurring that event driven managers would look for.”
But with greater returns comes greater risk and Jones of Key Asset Management says this is something that those operating there need to take into account.
“The opportunity set in Asia is as appealing as in the West although risk and return are generally higher in this space,” he said. “This area has been lacking the numbers of event driven hedge funds that can be found in Europe and the US so this focus is a result of the growth of new funds catching up with Western numbers.”
With event driven strategies able to take advantage of opportunities in both difficult and healthy markets, the outlook for the strategy is being touted as positive for the foreseeable future.
Many companies still have large amounts of debts that require refinancing over the coming years and this will present opportunities for astute fund managers.
The Credit Suisse Tremont Hedge Fund Index report earlier this year said: “Many expect the hedge fund industry to remain on an upward trend and continue offering investors attractive portfolio diversification benefits as well as competitive risk-adjusted returns.
“We expect managers will continue to capitalise on the various investment opportunities present in today’s market and we expect that returns in the near future will be largely driven by opportunities present in today’s market and we expect that returns in the near future will be largely driven by opportunistic market events and lower equity marker correlations. Furthermore, as funds continue to post positive returns across the board, we expect investors will continue to favour broad allocation, as opposed to sector specific positions, as a means of gaining diversified exposure to the asset class.”
That said, even event driven hedge managers are likely to post lower returns than they have done in the past – albeit they are expected to continue to outperform many other fund strategies.
The inability of company CEO’s to see clearly what the economic future will hold combined with the continued regulatory uncertainty in financial services means that M&A activity is likely to be slower than it has been in the past.
Yet Gradante at Hennessee Group told Global Investor/isf that he is confident investors will still be happy with their returns they are making in difficult conditions.
“I don’t see event driven strategies generating high double digit returns – 15-20% – I think they will do around 10%. The expectation is lower but it‘s still good.
By Mark Bonthrone
