In a booming year for mergers and acquisitions, hedge funds that seek to make money from corporate marriages are struggling.
The value of deals surged 43 percent in the first half of the year, with large takeovers reaching the highest number since before the financial crisis. That should have offered a fertile hunting ground for managers who bet on or against such deals. Yet their investment pools, known as merger arbitrage funds, lost money in the period, sending some investors fleeing.
The underperformance -- in a strategy that’s considered somewhat insulated from the usual market swings -- is caused in part by rising political risks to high-profile deals that blindsided some funds. The Trump administration this year blocked what would have been the largest technology deal ever, Singapore-based Broadcom Ltd.’s attempted purchase of Qualcomm Inc., while another deal was delayed by the increasing tensions between the U.S. and China. Spikes in market volatility are adding to the damage.
“U.S. deals are increasingly getting caught in a political slugfest and it’s difficult for fund managers to become political analysts," said Pierre Henri Flamand, who helps oversee $38 billion as chief investment officer of Man Group Plc’s GLG unit. “It has been a riskier environment since the couple of blow-ups we have seen.”
Merger-arbitrage funds seek to profit from the difference between the stock price of a target company when a deal is announced and the price when the transaction is completed. The larger the difference, or spread, the greater the potential profit for the fund -- unless a deal falls apart or faces long delays.
That’s what happened with Qualcomm Inc.’s bid for chipmaker NXP Semiconductors NV. The deal became a proxy in the U.S. and China trade war earlier this year, with Chinese antitrust authorities delaying the offer further on April 19. The shares, one of the most widely held positions across hedge funds, slumped more than 10 percent in April, inflicting losses on some event-driven money pools and causing deal spreads to widen across the industry.
While the shares have since rebounded, the slump caused losses at a number of hedge funds in April. The $1.2 billion PSquared Event Opportunity Master Fund lost 2.4 percent on its bet on NXP alone, while the Abrax Merger Arbitrage Fund lost 2.7 percent on its investment in the company, their letters to investors show.
A spokesman for Abrax said the fund has since recovered losses from NXP. Officials for PSquared didn’t return phone calls seeking comment.
Across the industry, merger-arbitrage funds fell 0.6 percent in the first half, and event-driven funds, which seek to profit from corporate actions more broadly, slumped 4.5 percent.
“Despite strong global deal flow, complex cross-border regulatory oversight and political and macro rhetoric has created an unprecedented amount of volatility across the merger-arbitrage space," said Jamie Sherman, a portfolio manager at London-based event-driven hedge-fund firm Kite Lake Capital that manages $1.1 billion.