Event-Driven Funds Gain Momentum
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In a year of lackluster returns across the hedge fund world, the event-driven sector is beginning to gather steam, according to hedge fund industry database consultants Hedge Fund Research Incorporated. The HFR index returned 1.27% in October and is up 7.02% for the year. Investors are rewarding this performance, adding $3.1 billion in capital to the sector, bringing the total event-driven assets under management to $116.7 billion.
As a result, event-driven is third out of the eleven strategies HFR tracks, with emerging markets and distressed securities, up 11.86% and 12.41% respectively. By comparison, the HFR fund weighted composite index – a weighted aggregate of all the funds and strategies HFR tracks – was up 4.5% by the end of October.
The event-driven strategy focuses on investing in what could be broadly termed “corporate life-cycle” events, such as spinning off divisions, acquisitions, mergers, divestitures, share buybacks, and bankruptcies. On a daily basis, an event-driven portfolio will often appear to be a combination of risk arbitrage and distressed securities portfolios.
The growing popularity of event driven funds is a result of investors’ desire to diversify away from the volatility of single investment strategies. By offering an event-driven component – often as part of a broader multi-strategy fund – the fund managers usually retain a larger chunk of the investor’s capital. This is because until recently, fund-of-funds and institutional investors would invest across several hedge funds to access these strategies. Moreover, the more investor capital retained, the greater the management fees and profit participation.
October’s event-driven performance was largely attributable to many managers having sizable chunks of their portfolios invested in distressed securities, a sector that returned 2.05% in October, according to HFR. In turn, distressed securities portfolios benefited from the expanding investor appetite for higher-yielding bonds – and the credit risk they entail – as interest rates remain near historic lows.
Event-driven managers are optimistic about the next few months. With a post-election equity rally in swing, corporate earnings strong, and equity mutual funds seeing inflows for the first time in seven months, many managers are hoping their risk arbitrage books profit from a pick-up in mergers. The idea is that CEOs have more ability to use their stock to buy rivals as equity prices rise. The first signs of this scenario are starting to play out with HFR’s merger arbitrage manager index up 0.66% last month, totaling over a third of the year’s 1.81% return.