With merger and acquisition (M&A) activity apparently picking up both in the UK and abroad, as demonstrated by the healthcare sector in particular, this could prove a fruitful time for the event-driven investor.
A research report by the Mergers and Acquisitions Research Centre at Cass Business School says this type of investing is also known as ‘risk arbitrage’.
The report – ‘M&A Event Trading: The influence of short-term traders’ – explains: “Risk arbitrage is an event-driven trading strategy which entails taking a position on the shares of the target and/or the acquirer.
“The risk arbitrageur abstains from taking a long-term view on the benefits of the transaction, but invests solely on their analysis of the probability of the success of a bid.”
The report reveals that this activity should increase market liquidity and improve the efficiency of equity pricing.
According to Fidelity Worldwide Investment, global M&A values rose 73 per cent in the first half of 2014, compared with the first six months of the previous year, with the overall value of deals topping $1.8trn (£1.1trn).
In its report on M&A activity published in August 2014, Fidelity notes that much of the growth in M&A deal values was recorded in the second quarter of this year, when deals amounted to $1.1trn (£677bn) – “the first quarter to break the $1trn mark since the second quarter of 2007”.
Jeremy Podger, portfolio manager, global equities at Fidelity, observes: “The recent surge in M&A deals underscores a growing willingness by corporates to finally deploy their cash-rich balance sheets.
“Favourable debt financing, low interest rates and good credit supply for leveraged buyouts is positive for equity holders of companies engaging in sensible strategic deals. This is underscored in the positive share price moves across both acquirer and target stocks.
“I expect this momentum in deal activity to continue through the rest of 2014, as the value of M&A transactions remains low relative to history if evaluated on a percentage-of-market-capitalisation basis.”
The report by Fidelity refers to several notable deals that have taken place in the year to date, including the $47.6bn (£29.3bn) acquisition of Shire by AbbVie in July this year, and Medtronic’s $42.9bn (£26.4bn) bid for Covidien. It refers to healthcare deals as the “prominent drivers” of global M&A activity.
Outside of the pharmaceuticals and healthcare industry, the cement industry saw the $39.5bn (£24.3bn) takeover of Lafarge by Holcim.
Angel Agudo, portfolio manager, US equities at Fidelity, believes that after years of cost-cutting, there is growing confidence among US corporates that could act as a further tailwind for markets during the latter part of 2014.
Event-driven investing, or risk arbitrage, is perhaps a more familiar concept to hedge fund strategies.
Chris Beauchamp, market analyst at IG Group, says: “For the brave, M&A deals can provide an interesting opportunity. News of a potential deal frequently leads to a rapid surge in stock prices, so keen shorters could enjoy a short-term trade if the shares of the target drop back following the excitement.
“A more effective method might be to take a more methodical approach, and take a look at companies whose shares have fallen considerably in the recent past and are now trading at attractive price to earnings (P/E) or price to book (P/B) ratios versus their peers.”
Mr Beauchamp admits that while these stories can take time to develop, the pay-off is worth it.
He concludes: “Combining this with a volume screen, noting which shares have seen significant uplifts in volumes, can be a handy way of narrowing down the list and provide some more promising candidates.”
Ellie Duncan is deputy features editor at Investment Adviser
