The Future Fund is using a combination of active managers and smart beta strategies to direct more capital into companies that have been identified as merger targets.
Future Fund manager of debt and alternatives John O’Keeffe told Investment Magazine that he had deployed a plan earlier this year to allocate more capital into investment strategies designed to capture “merger arbitrage”.
The opportunity set had been particularly attractive in recent months because a number of large international merger deals had either failed to get over the line or suffered lengthy delays. This has unsettled investors dampening their appetite to drive up the price of target companies.
A “flurry of outstanding mega-deals” in the market place had led to “significant spread widenings”, O’Keeffe said.
Two of the biggest mega-deal mergers of the past year to face lengthy delays have been the AB InBev-SABMiller tie-up and the AT&T-Time Warner merger.
AB InBev finally got its $US100 billion plus ($131 billion plus) acquisition of rival brewer SABMiller over the line in October, thirteen months after the deal was first flagged to the market.
AT&T and Time Warner last month announced plans for a $US85.4 billion ($112 billion) merger, which looks set to be delayed amid concerns from politicians and competition regulators.
“Earlier this year we identified merger arbitrage as an attractive strategy given the wide spread some of these deals were trading at, so we did a bit of work in understanding why spreads were wider than historic norms,” O’Keeffe said.
Typically, a merger arbitrage strategy is straightforward. When a merger is announced an investor buys the target company’s shares, which are usually trading at a discount to the offered price. The discount is present because there is a probability that the deal will not close and that the target company’s stock will retrace to the pre-announcement price.
“You obviously require risk premium to go in and buy those shares with the risk that they may not close,” O’Keeffe said.
Speaking at a Chartered Alternative Investment Analyst (CAIA) event in October O’Keeffe, who also heads up the professional body’s Australian chapter, said there were three methods to implementing a merger arbitrage strategy: passive, smart beta or through an alpha/event driven hedge fund manager.
Generally, the smart beta merger arbitrage products have a basic filter (compared to other smart beta products) which are used to invest in announced deals.
“There might be another filter when they only invest in deals with a combined market cap of X or they may only invest in strategic deals – which historically have a higher probability of closing than financial deals – but then they are largely agnostic; they will only do equal weighted allocation to every announced deal with no further analysis as to the probability that the deal will close,” O’Keeffe said.
At the Future Fund, Australia’s $124 billion sovereign wealth fund, he has implemented a merger arbitrage strategy through a combination of smart beta and active management.
O’Keeffe said an advantage of the smart beta approach was lower fees, and if an investor had the view that the broader merger arbitrage risk premia was attractive at that point of time the product might make sense.
However, if it was a case of picking losers and winners then a skilled manager would be required to underwrite the probability of deal breaks and be more circumspect how the position is put on.
“Maybe you don’t just invest in the target company, maybe you use derivatives, if things like vol [volatility] are cheap maybe hedge your book, or maybe you even short some deals if you think the universe of risk premia is just too expensive.”