Strategies for the event-driven investor

This article is part of
Event-Driven Investing - September 2013

Vodafone’s sale of its stake in Verizone Wireless and Microsoft’s purchase of Nokia’s handset business are just the type of corporate deals that interest event-driven investors.

Joe Childs, manager at Hedge Fund Performance, explains: “Event-driven investing is an investing strategy that seeks to exploit pricing inefficiencies that may occur before or after a corporate event, such as a bankruptcy, merger, acquisition or spin-off.”

Once primarily used by hedge funds, event-driven investment strategies are increasingly being used by managers of Ucits funds that are available to the retail investor. It could even be argued that the majority of active equity fund managers, to some degree, use an event-driven strategy as part of their process.

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According to Towers Watson, the key investment driver behind this strategy is “identifying the mis-pricing of assets due to events such as M&A or corporate restructurings”, and the outcome of these events are not always linked to economic factors which means decent returns can be made in spite of ongoing macroeconomic turbulence.

Co-head of the RWC European Focus fund Maarten Wildschut, explains: “The short-term orientation of financial markets can often lead to mis-pricing of the shares of companies that are undergoing change. With an in-depth understanding of companies and their transformational opportunities, active owners are in a good position to generate strong returns.”

Event-driven investing comes in many forms. Those adopting the strategy may focus on merger and acquisition activity, corporate restructuring, distressed debt securities or active ownership.

Chris Jones, head of alternatives at bfinance, advisers to institutional investors and corporations, explains: “Returns, for example, are driven by the deal premium, the deal flow in mergers, by the default rate, the discount to fair value in distressed debt. There is also a return coming from liquidity premium or, to be more precise, illiquidity premium.

“A lot of distressed debt is semi liquid and can quickly become illiquid in the sense that the hedge fund manager doesn’t want to sell at a completely decorrelated price.”

Active ownership is slightly different and sees investors take a significant stake in a company that they feel is currently being mis-managed and engage with that management team in order to improve future share price performance.

Mr Wildschut’s co-head on the RWC European Focus fund, Petteri Soininen, explains: “Active ownership seeks to generate sustainable shareholder value by improving economic value creation within portfolio companies, reduce discounts through improving interaction with capital markets and improving corporate governance.”

It is argued that the event-driven strategy is largely uncorrelated to the wider macroeconomic events that affect stockmarket.

Towers Watson’s global head of hedge fund research Damien Loveday, explains: “Event-driven strategies can be a source of idiosyncratic returns. For example, the split of assets in a liquidation situation is determined purely in court and the outcome of M&A transactions is often determined by regulators.

“Additionally, for managers with the flexibility to move in and out of event-driven, and between the various strategies, there are different opportunities available throughout a market cycle.