Putting the strategy in place

However, returns for the strategy are not uniform and do exhibit some correlation with other metrics, such as interest rates and economic activity. How do event driven strategies naturally fit into a portfolio?

Research by US-based manager Quaker Funds shows that event driven strategies display relatively low correlation to traditional equity indices. It shows that the HFRI Event-Driven index, which measures the aggregate performance of event driven hedge funds, had its weakest years in 2008 and 2011, in common with the S&P 500 index, but while the S&P lost 37 per cent in 2008, the HFRI Event Driven index lost just 21.8 per cent. Event driven strategies have also shown lower, but more consistent returns in positive years. In 2009, the strategy gained 25 per cent, in 2010 11.8 per cent and in 2012, 8.88 per cent.

But the years since the credit crisis have not been great years for this type of fund. Amit Shabi, a partner at event-driven hedge fund house Bernheim Dreyfus, says: “Since the credit crisis, distressed debt funds that buy bankrupt companies have done very well. Some credit strategies also did well as credit spreads tightened significantly. However, merger arbitrage funds have suffered, particularly in the last couple of years, because there has been a significant lack of merger and acquisition activity. Also, the level of interest rates was very low and there was complexity in regulation.”

This has started to change as economic activity has picked up. There have been a series of high profile deals: Vodafone selling its stake in US-based Verizon, for example, Microsoft’s purchase of Nokia’s mobile phone business, as well as ongoing deals in the healthcare sector. The Financial Times highlights Dell, Apple and Herbalife as some of the companies to have come under intense activist-investor pressure this year, but there are also an increasing amount of hostile takeovers, which has enabled better performance from this type of event driven manager.

Data from Hedge Fund Intelligence (HFI) shows event-driven strategies were the second best performing hedge fund strategy in August (after single manager African funds) and in July (after Equity funds).

However, a point worth noting is that Event Driven Absolute Ucits funds have performed considerably worse than their non-Ucits equivalent. The HFI database shows that Ucits-event driven strategies returned just 2.33 per cent for the year to date, worse than equity market neutral and quantitative strategies, European equity and fund of funds strategies. This suggests that the event driven strategies contributing most to performance are not available in a Ucits format.

Mr Shabi says that all event driven strategies tend to perform best at times of high volume merger and acquisition markets: “This type of manager likes it when there is plenty of corporate activity,” he says. “Mergers and acquisitions usually happen when there is plenty of confidence in the market.”

This correlation with higher activity and confidence also creates the correlation to interest rates. Mr Shabi says: “When interest rates are low, it may be easier to finance debt, but it means that the economy is not doing as well. When interest rates are higher, there is more confidence. Rationally, companies should buy when interest rates are low but there is often just not enough confidence. When other people are buying, everyone wants to buy.” Apart from manager skill, different managers will vary the amount of leverage and directionality in their funds to generate returns.

He adds that the current climate is favouring those event driven managers more focused on merger and acquisition activity. He runs a fund of event driven hedge funds and will change the weightings in the underlying holdings to match market conditions. When there is a greater volume of merger and acquisition activity, as at the moment, he will increase the weighting to special situations funds.

In 2008, he significantly increased his weighting to merger arbitrage and distressed funds. Event driven strategies also like a relatively calm risk environment: The outcome from a potential deal needs to be predictable and this is easier to do in less volatile markets.

There are event driven strategies that made a killing in the credit crisis, making their investors many times their money. However, this is relatively rare and most investors will use event driven strategies for portfolio diversification purposes. If markets remain calm, and are not derailed by war in Syria, the paring back of quantitative easing, or another crisis in Europe, it may be a better time for this type of fund.

Cherry Reynard is a freelance journalist