This year, betting on corporate takeovers and restructurings should have been a sure thing for investors as the value of deals soared to record levels. It didn’t work out that way.
Hedge funds that look to profit when companies are acquired or do other major corporate maneuvers dropped an average of 2.29 percent this year through November, making them the only major investing style to lose money, according to HedgeFund Intelligence. The S&P 500 Index rose 4.78 percent over the same period, including dividend payments.
“It turned out to be a very challenging year,” said Tristan Thomas, who helps clients select hedge funds at Northern Trust’s 50 South Capital. “A few crowded stocks hurt a large number of the brand name funds.”
The poor showing by managers of funds that focus on mergers and other corporate events, known as “event-driven funds,” gives further ammunition to critics of the industry, who complain that hedge funds charge high fees for mediocre returns.
It isn’t just this year that has been bad for the funds. Their longer-term average annual returns are even worse. Since January 2010, event driven hedge funds gained an annual average of 4.43 percent versus 13.3 percent for the S&P 500; since January 2005, the funds gained an annual average 5.53 percent versus a 7.5 percent return for the benchmark stock market index.
Among the big losers were some of the biggest names in the hedge fund world, such as Bill Ackman’s Pershing Square Holdings (down 22 percent through December 15); Richard Perry’s Perry International (down about 9.7 percent through November); Mick McGuire’s Marcato International (down about 9 percent through December 15); and James Dinan’s York Capital Management LP (down 12 percent through November), according to performance information reviewed by Reuters.
The funds make big bets on relatively few companies, because of the intense amount of research involved. The big problem was that many of the stocks that were widely held by event-driven funds turned out be clunkers this year, including drug company Valeant Pharmaceuticals, which plunged more than 55 percent after short-sellers and lawmakers raised questions about its accounting, pricing practices, and the tactics it used to get insurers to pay for certain drugs.
Another popular bet for event-driven funds was Yahoo Inc, whose shares have fallen by about a third this year after the company scrapped its efforts to spin off its stake in Chinese e-commerce giant Alibaba Group Holding Ltd, because of concerns that shareholders would face a huge tax bill.
Combined with Valeant and Yahoo, popular event-driven names Williams Companies and Qualcomm represent four of the 20 worst hedge fund stock bets of the year by dollar amount, according to public disclosures of Sept. 30 holdings analyzed by research firm Novus.
Shares of energy company Williams have fallen by 57 percent over the past six months after the company rejected a takeover bid by Energy Transfer Equity in June, but accepted a much lower bid from the same suitor in September. And technology company Qualcomm decided earlier this month, after a review, that splitting into two didn’t make sense. That and other business concerns have pushed its stock down more than a third this year.
At the beginning of the year, betting on mergers seemed to make good sense.
In January, Robert Duggan, a portfolio manager who invests in hedge funds on behalf of clients at SkyBridge Capital, noted that there was a “significant opportunity” for event-driven fundsthanks to the large number of deals in the works, and the relatively high levels of cash on companies’ balance sheets to either pay out to investors or use for acquisitions.
Managers that take advantage of mergers and acquisitions and other company moves were $13 billion SkyBridge’s top strategy pick. It bet big on hedge funds run by ultra-wealthy investors John Paulson, Dan Loeb and Barry Rosenstein, among others, according to a public filing at the time.
SkyBridge was right on deal making: with only 7 days left in the year the value of M&A deals globally has risen nearly 41 percent from 2014 to a record $4.6 trillion, according to preliminary Thomson Reuters data. But picking the right events turned out to be tough.
SkyBridge is down more than 4 percent in 2015 through November in its Series G fund ofhedge funds, according to a public filing. Event-driven hedge funds run by Paulson’s Paulson & Co., Loeb’s Third Point and Rosenstein’s JANA Partners are down for the year. Swiss fund offunds Altin is up 1.4 percent through December 21, but its performance was held down by a nearly 30 percent allocation to event-driven managers, including losing funds like Jana Nirvana and Paulson Enhanced, according to marketing materials.
A group of mutual funds that allocate to hedge funds – so-called liquid alternatives – have lost money this year thanks in some part to event-driven managers in their portfolios. They include, according to public disclosures, the Goldman Sachs Multi-Manager Alternatives Fund, Neuberger Berman Absolute Return Multi Manager Fund, Hatteras Alpha Hedged Strategies Fund and Arden Alternative Strategies Fund.
Michaël Malquarti, an Altin portfolio manager, said that it seeks to reduce the risk of suffering big losses from hedge funds that have concentrated bets on corporate events by avoiding allocating too much of their portfolios to those funds.
Others declined to comment or did not respond to requests.
It’s not all gloom.
Some were able to make money with the right bets. The $600 million Polygon European Equity Opportunity Fund, managed by Reade Griffith, and the $1.7 billion HG Vora Special Opportunities Fund, led by Parag Vora, are both up more than 6 percent through November, according to a person familiar with the situation. And the nearly $620 million Tosca Opportunity fund, led by Martin Hughes, is up about 10 percent for 2015 through November, according to performance information seen by Reuters.
The funds appear to have gained by mostly avoiding the popular U.S. stock bets that hurt others and instead focusing on smaller companies, including those in Europe and Asia.
The sector is also far from contracting despite the setbacks. Some 56 event driven hedge fundslaunched over the first three quarters of 2015, according to data tracker Hedge Fund Research, compared with 45 liquidations.
There has also been nearly $11 billion in net investment added to all event-driven funds over first three quarters of 2015, according to HFR, and assets in the strategy sit near record highs at $745 billion.
Pensions and other institutional investors continue to increase their hedge fund allocations, even as the California Public Employees’ Retirement System, one of the largest pension group’s in the world, cut most of its hedge fund managers last year, citing “complexity, cost and the lack of ability to scale.” The pension did retain its portfolio with activist investors, who agitate for change by attempting to gain board seats, win shareholder votes and more.
And many investors in hedge funds remain bullish on the strategy. Goldman Sachs Asset Management, Neuberger Berman, Franklin Templeton Investments’ K2 Advisors, Citi Private Bank and Pacific Alternative Asset Management Company all have a positive outlook for event-driven managers going into 2016.
“We remain cautiously optimistic,” said Putri Pascualy, a managing director at PAAMCO. “Security selection will be paramount in identifying events that are still viable despite recent market volatility.”