Merger arbitrage grows
Market-neutral managers that survived the difficult conditions of 1998 enjoyed a good year in 1999, ...
Market-neutral managers that survived the difficult conditions of 1998 enjoyed a good year in 1999, according to research by Global Fund Analysis.
A common explanation cited by managers was less capital was competing for trades in their strategy, allowing them to reduce leverage and still make their target return, typically in the low teens after fees.
Owen Brolley, senior analyst at Global Fund Analysis, said: "A welter of corporate activity gave equity-based strategies ample opportunity to generate good risk-adjusted returns. Merger arbitrage, event-driven and relative value strategies all profited from an increase in transactions."
In the US, rapid and wide dissemination of information via the internet has made consumers resistant to price increases. In order to protect margins companies have been forced to acquire market share.
Brolley said: "The successfully acquisitive companies have been rewarded by Wall Street with premium valuations and this has encouraged more corporate activity. Rich stock prices, too, have contributed to the merger frenzy as boards, quite sensibly, wish to purchase as much as possible when their currency is expensive."
In addition, shareholder activism has been in the ascendant throughout Western Europe, taking a lead from the US example of underperforming corporations being acquired by rivals with the ability to improve shareholders' return on equity.
Brolley said: "Introduction of the euro expedited this process by eliminating the obfustications of cross-currency comparisons. When Vodafone Airtouch made a hostile bid for Germany's Mannesmann and it was accepted, it was hailed as a seismic shift in the European corporate landscape."
Ralph Rocco, fund manager at Gabelli Associates, sees the trend in mergers continuing.
He said: "Worldwide there were $3.4 trillion in deals announced in 1999, topping the record $2.5 trillion in 1998. This compares with the $464bn in deals done worldwide in 1990.
"The drivers for all this activity have been the lowering of regulatory hurdles, globalisation, more cosmopolitan European management teams and strong financial markets.
"We believe this trend will continue, not least because competition from the internet in sales and distribution means that even established companies feel themselves at risk. The fear that only the top two or three corporations in an industry will survive the intense competition is a powerful incentive."
Rocco sees more room for deals in the telecommunications sector, broadcasters and media around the world.
He added: "In Europe, we see deals in the making in deregulating industries, including the manufacturing sector where the need for scale and critical mass are becoming all the more apparent."
In the convertible bond market, convertible arbitrageurs reported their asset class at historically cheap levels. Brolley said: "In European bonds there was a glut of issuance during the summer months that depressed prices. If demand in the primary market was thin, the secondary market was a reluctant buyer.
"Since the equity markets appeared to be a one-way bet in 1999, implied volatilities of indices and underlying stocks reached low levels leading to further losses.
"US convertibles, which as an asset class tends to be of lower credit quality, suffered when the Federal Reserve started to raise interest rates.
"There was even less activity than normal during the summer from proprietary trading desks who did not want to take positions ahead of the enormous supply scheduled to hit the market in autumn. Potential illiquidity surrounding the year 2000 issuance also discouraged participants and anchored returns."
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