Q1 2020 Review
During the first quarter of 2020 global markets experienced unprecedented volatility largely due to the ongoing global pandemic and the price war surrounding oil. Having that said, our arbitrage strategies once again demonstrated their resilience in the face of calamitous market conditions during the period.
In late February to early March, we materially de-risked the portfolio of names we felt had direct pandemic exposure. In mid-March we began to see the effect of forced de-risking by some of the weaker hands in the arbitrage community. Large U.S. multi-strategy hedge funds and quantitative funds with significant losses in other parts of their portfolios were forced to sell arbitrage positions at frankly unprecedented levels. This resulted in extreme volatility in merger arbitrage, surpassing even 2008 in terms of dislocation of spreads. While spreads have been volatile, the actual news flow surrounding mergers and acquisitions has been benign and in fact quite positive. Many buyers have been re-iterating their commitment to deals with some even asking for standstill waivers to permit them to buy shares of the targets in the open market. No deals have broken.
Keep Calm and Carry On
It is important to remember that merger contracts are legally binding obligations that don’t afford the purchaser a right to walk away in the face of changed market conditions. There is a body of case law concluding that any material adverse event needs to affect the target company disproportionately and in a durationally significant manner. With the widespread impact of the pandemic and trial judges having determined that “durationally significant” means several years, it is not surprising to us that we have not seen any deals break. In fact, the opposite is occurring with deals closing on schedule in a wide variety of sectors including aircraft leasing, communications (the massive Sprint/T-Mobile deal), utilities, technology and so on.
Going forward, while it is unlikely that M&A activity quickly returns to pre-pandemic levels, we do know there will continue to be deals. In early 2009, in the midst of the global financial crisis, we continued to see $50-$100 billion of deals announced quarterly. Buyers with strong balance sheets will look to opportunistically buy assets they have coveted for many years. This leads to very high-quality deal flow. Additionally, with a significant number of competitors being forced to exit arbitrage, we expect spreads to continue to be more attractive on a risk/reward basis.
Special Purpose Acquisition Companies (SPACs)
SPACs were also resilient in Q1. As the common shares represent a legally binding claim on U.S. T-Bills in an escrow account held in trust, they are among the most secure investments available. However, they are not immune to liquidity-driven sell-offs, and we did see some forced sellers in the SPAC market. Anecdotally, highly levered credit players were forced to sell SPACs because they were among the more liquid parts of their portfolios. This provides us the opportunity to add to our SPAC weight at attractive yields to trust - similar to rates of return to what we saw in 2008, which is an attractive risk vs. reward opportunity in our opinion.
During the period our suite of Arbitrage funds reached a few minor milestones. Our Picton Mahoney Arbitrage Plus Fund celebrated it’s 3-year anniversary and both the Picton Mahoney Fortified Arbitrage Alternative Fund and Picton Mahoney Fortified Alternative Plus Fund celebrated their 1-year anniversaries.
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