Picton Mahoney portfolio manager explains how strategy dealt with COVID-19 and why it remains an option in all markets
The desire for M&A activity is coming back, solidifying merger arbitrage as a way to add ballast to an investor’s portfolio.
Earlier this year, Picton Mahoney Asset Management strengthened its line-up of alternative solutions by acquiring merger arbitrage strategies from Vertex One Asset Management Inc. The hedge fund-style approach is designed to fortify a portfolio by capitalizing on price inefficiencies caused by the successful completion of merger and acquisition deals.
Craig Chilton, portfolio manager, merger arbitrage, told WP that its fund has been relatively unaffected by the COVID-19 crisis, although the “Arb” space went through some initially testing times when the virus first hit. The immediate reaction was questions over a “material adverse effect”, which permits the acquirers to terminate the deals if they so desire. This is a high bar, however, and Delaware law made clear nobody could use a pandemic as a reason to back-track on a commitment to closing a deal.
Then the markets went crazy and many people rushed to sell. Those trying to get out went for a different angle, saying that the target companies were no longer operating in the “ordinary course”, which meant it was a breach of the merger agreement and that they could terminate.
Ultimately, Chilton said, deals closed and buyers didn’t walk away, which provided a level of comfort despite the COVID-19 uncertainty. There were exceptions, of course, with the most high-profile one in Canada being Cineplex, which had an agreement to be acquired by Cineworld, one of the world’s biggest theatre chains, but who walked away from the agreement. Cineplex has filed a lawsuit against its former suitor, seeking damages over the failed acquisition that could exceed the $2.18 billion outstanding on the deal.
Chilton said Picton’s focus on SPACs (Special Purpose Acquisition Company) has created good performance and become a favoured way for companies that were looking to go public during these times to access the public markets. A number of De-SPACs have done well - up to five times from their costs – meaning Picton’s relative weight of two-thirds M&A and one-third SPACs has been flipped on its head.
More M&As are coming to the table, however, and recent events have shown that merger arbitrage remains an excellent defensive position.
Chilton said: “When the markets were selling off 35%, the strategy was down 5%. It’s very defensive and yet it allows you to generate returns that are the best of the super low risk investments, like cash or GICs or short-term bonds. In other words, we're getting a good return for the unit of risk that is taken.
“It’s also never a case of ‘Oh, is now a good time to be in ARB?’. It's more of a ballast type of portfolio weighting. It’s always a good time to have 'Arb' in my mind because it's a unique source of return that you typically don't have in your portfolio. You might have equities and you might have fixed income, but you probably don't have anything where the returns are not from interest rates or equity market, but rather from the successful completion of M&A transactions. Your source of return is a diversifying element, which makes your portfolio more robust overall.”
Uncorrelated to the markets, able to hold up in times of stress and also generate attractive returns, Chilton said investors should also consider Arb given that we are in an era of low rates and low income.
“You might want to take off equity risk and move into a type of investment that would shelter you if the markets were to take another move lower but at the same time allow you to generate a return.
“There are a whole variety of reasons why someone might want Arb in their portfolio. But I think the long run returns show that it's an investment that has proven its ability to generate consistent returns over all markets and over long periods of time.”