Single manager


Record M&A activity helps drive merger arbitrage strategies

Blake Hiltabrand, Head of Merger Arbitrage Research and Senior Portfolio Manager

Investors continue to face a number of risks in markets that were not front-and-center during the post-2008 financial crisis recovery. Many are turning to the world of alternatives, and in particular, market neutral and arbitrage strategies, as a source of diversification and alpha in an environment that has become increasingly unpredictable.

Merger Arbitrage is a strategy that seeks to capture the risk premia associated with announced transactions. In a world of increasing risk premia and transaction volumes, this traditional hedge fund strategy has begun to regain the attention of asset allocators across all regions, as they seek absolute returns with low correlation to the broader markets. We believe there are both structural and cyclical forces at play that add to the attractiveness of the space.

Record M&A deal volumes paired with wide spreads

To say the least, 2018 has been a truly unprecedented year for those that invest in merger arbitrage. Merger arbitrage returns are typically a derivation of either a robust deal environment or wide spread levels – though it’s unusual to experience both at the same time. High corporate confidence and low risk premiums typically go hand in hand with greater transaction volumes. So why now, when we look at the global M&A opportunity set, do we see record deal volumes coupled with substantially wider spreads?

If you turn to the front page of any newspaper, you would be hard-pressed not to find mention of significant deal activity in the headlines. Whether it is a rebound in deal activity in Europe after a decade of lacklustre corporate confidence or transactions in the US on the back of recently enacted corporate tax reform – it is obvious to even the most casual observer that the impetus for M&A is growing. As seen below in Exhibit 1, the first half of 2018 has reached record heights in terms of deal volume and size.

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.

UBS Asset Management in the United States

The website contains general information about UBS Asset Management (Americas), Inc., UBS Hedge Fund Solutions LLC, and UBS O'Connor LLC, collectively known as "UBS Asset Management". The information contained on this website does not constitute investment advice or a recommendation to purchase or sell any securities or other financial instrument or any particular strategy or fund. Market commentary, product information and related performance data available on this website has been compiled from sources believed to be reliable and is provided in good faith for informational purposes only. UBS Asset Management does not guarantee the accuracy, suitability or completeness of information contained on this website, and all such information, including but not limited to performance data and related metrics, is subject to change without notice. Certain content on this website is intended for institutional investors and their financial representatives only, and should not be relied upon by retail investors or members of the general public.

Market commentary and similar statements contained herein are based on current expectations and may be considered “forward-looking statements.” Actual future results, however, may prove to be different from expectations. The opinions expressed are a reflection of UBS Asset Management’s best judgment at the time of posting, and any obligation to update or alter any forward-looking statement as a result of new information, future events, or otherwise is disclaimed.

Investments involve risks, are not guaranteed and may not return the original principal amount invested. Past performance is no guarantee of future results. Investors should read all available product information carefully before making an investment decision, including information about applicable risks, fees and expenses. This website does not address the investment objectives, risk tolerance or financial needs of any particular investor. In addition, any statements regarding investment performance expectations, risk and/or return targets do not constitute a representation or warranty that such expectations or targets will be achieved.

This website is not intended for persons located in any jurisdiction where the availability of this website is prohibited or contrary to local law or regulation or would subject any UBS entity to any registration or licensing requirement in any such jurisdiction.

Please confirm you are a US resident to proceed.

Please select at least 1 checkbox