European M&A activity has turned so lackluster this year it’s forcing a merger arbitrage fund to take bigger risks for returns.
(Bloomberg) — European M&A activity has turned so lackluster this year it’s forcing a merger arbitrage fund to take bigger risks for returns.
Trium Capital LLP’s Felix Lo is telling investors to expect more portfolio volatility this year, as he increases exposure to so-called complex deals, which face risks such as regulatory hurdles before completion.
“There is a lot of room for us to make money where there is higher risk, but the spread compensates you for that, so you just have to be right,” said London-based Lo, who manages global merger arbitrage fund Khartes at Trium. “With more complicated deals in the portfolio we should still be able to deliver good returns but potentially there might be more volatility from month to month.”
Merger arbitrage funds, which buy shares of a deal target and pocket the difference between the purchase and offer prices, are facing tough choices this year. M&A activity is fizzling out amid tightening financial conditions and banking turmoil. Earlier this year, event-driven hedge fund Aslan House Capital LLP said it’s returning capital to investors and shutting down.
The dearth of straightforward, so-called clean deals, is driving Lo to riskier bets. Among his investments this year is UK health tech firm EMIS Group Plc, in which he had a holding as of March 24. The company’s shares had rallied after it agreed to be acquired by UnitedHealth Group Inc.’s unit last June, but plunged on March 31 after Britain’s competitions regulator referred the deal for in-depth review.
While Lo, who manages about $99 million, wouldn’t confirm the fund’s latest positioning in the stock, he expects a remedy package will allay the regulator’s concerns. Lo’s fund Khartes returned 11% in 2022, according to HSBC’s Investment Funds Performance Review, outperforming the HFRX ED Merger Arbitrage Index, which fell about 0.3%.
Complex deals now account for half of his fund’s portfolio, up from as little as 20% earlier, he says, although it’s roughly the same when viewed as percentage of net value.
Another of Lo’s favorite situations this year involved Finnish building maintenance services provider Caverion Oyj, which was the target of a bidding war between Bain Capital-led consortium and Triton Fund V. Caverion’s board on April 5 recommended that investors favor the offer from Triton.
The drought in Europe has also prompted Lo to raise the fund’s US exposure to 40%-45%, up from 25% last year. The value of deals in Europe has slumped almost 60% in the first quarter from a year earlier, according to data compiled by Bloomberg.
More broadly, Lo says the biggest risk to M&A activity is market confidence, after the banking turmoil last month. He expects dealmaking to pick up once sentiment improves.
–With assistance from Michael Msika.
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