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Merger arbitrage hedge funds show their mettle amid market mayhem

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Merger arbitrage is proving the most resilient hedge fund strategy amid the continued global volatility sparked by the coronavirus outbreak, according to Lyxor Asset Management.

Merger arb strategies were down just 0.4 per cent since the 18 February equity peak, while a traditional 50/50 equities and bonds portfolio has lost 4.6 per cent, based on the MSCI World and Barclays Global Aggregate Bond indices, up to 3 March, Lyxor strategists observed on Tuesday. The strategy was resilient in a context where deal spreads were stable up to 28th February and widened afterwards. 

The recent widening of deal spreads offered opportunities to deploy capital in high conviction deals with strong risk-reward profiles. Lyxor pointed to several such deals where managers have deployed capital, including Tiffany vs LVMH, E*TRADE vs Morgan Stanley, and UBI vs Intesa.

Lyxor’s weekly briefing note, by Philippe Ferreira, senior strategist, Jean-Baptiste Berthon, senior strategist, and Montassar Jamai, hedge fund analyst, said the resilience stems from the strategy’s low beta approach, with trades in this sector structurally isolated from broader market movements.

“Merger arbitrage is an active strategy. Under such circumstances, managers have reduced the duration of the portfolio and concentrated it on high conviction deals,” they noted. 

Historically resilient during market turmoil when other risk assets sell off sharply, merger arb fell less than 5 per cent over the course of the 2008 crisis, while the MSCI World index plummeted some 50 per cent. Similarly, during the early 2000s dot.com crash, merger arb grew some 15 per cent when the MSCI World was down 45 per cent. 

Elsewhere, Lyxor’s note pointed to long/short credit and market neutral long/short strategies among the hedge fund strategies that have done well lately, thanks to their low market directionality. On the flipside, CTAs and directional long/short equity hedge funds have underperformed since the recent uptick in volatility.

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