Event driven investing and the ‘value gap’
We are in the midst of a merger boom: 2015 saw record levels of activity and this has strongly continued into 2016. A combination of high cash balances, low interest rates and slow economic growth have driven company management teams to sustain and improve margins through deal-making. There has been high profile activity in a range of sectors globally, led by corporate combinations in the industrial and technology sectors.
Although the UK’s Brexit vote caused uncertainty for some transactions – namely transactions involving UK companies – the conditions for the elevated levels of merger and acquisition we have seen over the past 18 months remain strongly intact.
Chief executives have three primary levers with which they can drive their share prices higher.
- They can expand their price to earnings multiple, though this is quite difficult at a time when multiples are already at historic highs.
- They can cut costs to improve margins, though this is similarly impractical as margins are already at peak levels following post-2008 cost cutting.
- Finally they can drive topline growth.
There are two components of topline growth: organic and inorganic.
Organic growth has become increasingly difficult in a climate of weak economic growth. In spite of unprecedented monetary stimuli, many developed economies have struggled to generate self-sustaining growth, making it difficult for companies to grow organically.
This leaves a single viable options for CEOs: growth through M&A.
Further, it is increasingly cheap for companies to borrow: negative interest rates are commonplace and companies can issue debt at record low levels. Many were already sitting on high cash balances, a legacy from the uncertainty created by the 2008 financial crisis.
The BlackRock Strategic Funds Global Event Driven fund is built on the premise that these transformative corporate events can create mispricing and therefore opportunities to generate alpha. Event driven investing focuses on capturing the value gap created when companies undergo these transformative events or “catalysts”. We invest in companies that have announced a material change or expect to undergo a material change that is likely to impact shareholder value.
These investments typically correlate less with day-to-day market movements and rather are driven by the outcome of each event. Due to this idiosyncratic nature, event driven strategies are designed to generate positive returns irrespective of overall market moves.
Currently the opportunity set in merger arbitrage is particularly attractive. To capitalize on this timely opportunity, the fund is predominately (98%) invested in mergers and acquisitions, well diversified across sectors and market capitalizations. We find these transactions particularly compelling as they tend to have an extremely low correlation with equity markets, providing the portfolio protection against much of the uncertainty we’re seeing in markets. The current beta to the S&P 500 is just 0.121. Looking ahead, we expect these market conditions to persist for the foreseeable future and remain incredibly excited about the robust opportunity set available to us.
1Source: BlackRock, 22nd August
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Fund Specific risks
Exchange rate risk –BSF Global Event Driven Fund, invests a large portion of assets which are denominated in other currencies; hence changes in the relevant exchange rate will affect the value of the investment.
Emerging market risk – Compared to more established economies, the value of investments in developing Emerging Markets may be subject to greater volatility due to differences in generally accepted accounting principles or from economic or political instability.
Credit risk – The BSF Global Event Driven Fund invests in fixed interest securities issued by companies which, compared to bonds issued or guaranteed by governments, are exposed to greater risk of default in the repayment of the capital provided to the company or interest payments due to the fund.
Liquidity risk – The BSF Global Event Driven Fund investments may be subject to liquidity constraints, which means that shares may trade less frequently and in small volumes, for instance smaller companies. As a result, changes in the value of investments may be more unpredictable. In certain cases, it may not be possible to sell the security at the last market price quoted or at a value considered to be fairest.
Long/Short fund – The value of the BSF Global Event Driven Fund does not typically move in line with general market trends and is not expected to reap the full benefits of a rising stock market. Investment strategies employed by the manager may affect the risk profile of the fund, as both positive and negative share movements affect the overall value of the fund. Regardless of market conditions, the fund aims to deliver a positive absolute return for clients, rather than tracking or seeking to outperform a benchmark or index. Investors in these funds should understand that the funds are not guaranteed to produce a positive return and as an absolute return product, performance may not move in line with general market trends or fully benefit from a positive market environment. The Managers employ a risk management process to oversee and manage derivative exposure within the funds.
Complex Derivative Techniques – The strategies utilised by all of the funds in this document involve the use of derivatives to facilitate certain investment management techniques including the establishment of both ‘long’ and ‘synthetic short’ positions and creation of market leverage for the purposes of increasing the economic exposure of a fund beyond the value of its net assets. The use of derivatives in this manner may have the effect of increasing the overall risk profile of the funds. Investors in these funds should understand that the funds are not guaranteed to produce a positive return and as an absolute return product, performance may not move in line with general stock market trends as both positive and negative share movements affect the overall value of the funds. The Managers employ a risk management process to oversee and manage derivative exposure within the funds.
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