So then we turn to the other driver of returns in merger arbitrage: risk premia, or the spread. After a deal is announced, the security of the target company generally trades at a discount to the consideration the acquirer has offered to pay. That discount can vary substantially from situation to situation based on the risks inherent in the completion of the transaction. This is where the hand-off occurs from the traditional owners of the security, who likely were invested based on their views around the sustainability of the business, cash flows, value or potential catalysts such as an acquisition. These investors do not specialize in evaluating legal, regulatory, financing or political risk – and thus most public companies involved in mergers experience a massive redistribution of the shareholder base post announcement. Arbitrage investors look to profit from the over-estimation of risk by those who do not specialize in analyzing these risks consistently across situations, regions and over time. This type of market neutral investing was historically very common amongst bank proprietary trading desks, but with the Volcker Rule, we have seen the amount of capital dedicated to this strategy substantially shrink, creating the environment for wider spreads and a structural opportunity for investors.
The US administration has injected immense uncertainty into that market, particularly with regard to trade policy, resulting in wider spread levels. There have been surprising challenges from the Department of Justice, which have also elevated the perception of risk in the M&A space. Once again, merger arbitrage investors who have the experience in evaluating the various risks involved in these transactions have the potential to reap the benefits.
That brings us to today and where we believe the opportunity is headed in the coming years. It is our belief that uncertainty from political/policy actions emanating out of the current administration is the "new normal". These risks are real, but often significantly over-dramatized by the market, creating a target rich environment for those who specialize in evaluating these situations and risks. That, coupled with the continued "animal spirits" from the corporate board rooms to grow via acquisition, presents us with what we think is a truly attractive M&A landscape for the foreseeable future.