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Merger arbitrage a lower-risk option to play US regulatory changes

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Event driven was the top-performing hedge fund strategy in 2016, with the HFRX Event Driven index up 11.1 per cent in USD terms, according to the latest monthly hedge fund update from GAM portfolio manager Kier Boley.

The HFRX Event Driven index has also started 2017 brightly with returns of 1.1 per cent in January.
 
The event driven space also saw significant dispersion: distressed and special situations-based managers performed particularly well, given recoveries in beaten up deep value stocks and credits, while merger arbitrage had a more modest run, with the HFRX Event Driven Merger Arbitrage index returning 4.3 per cent for 2016 and losing 0.3 per cent in January.
 
GAM continues to have a positive view on the merger arbitrage space as a potential source of differentiated returns. While merger volume declined in 2016 and began the new year modestly, there is a chance that new leadership at US regulatory agencies in the coming months will have a broadly positive impact on deal flow and spreads in pending transactions, Boley (pictured) says.
 
In January, President Donald Trump announced new leadership at the Federal Trade Commission (FTC), generally believed to be friendlier towards business and less so towards regulation. It is expected that there will be further restructuring at the regulatory agency over the coming months.
 
Should regulatory bodies like the FTC take a more business friendly and anti-regulation approach, as expected under new Republican leadership, corporations will likely have more confidence in seeking mergers, particularly intra-industry, providing more merger transactions to invest in. Moreover, regulatory-related deal risks would diminish, increasing the likelihood that pending deals will close as expected and merger arbitrage strategies would benefit from current investments, Boley says.
 
As a further fillip to performance, merger arbitrage spreads should see support as and when interest rates increase, as arbitrageurs require a higher level of compensation in order to carry deal risk from announcement to completion.
 
Given the high level of political uncertainty that does not yet appear to be reflected in levels of equity volatility, merger arbitrage could provide a lower-risk way to take advantage of regulatory changes, concludes Boley.

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