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February 24, 2024
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Hedge Funds Trading on M&A Catch a Break as Deals Pick Up


(Bloomberg) — The tide finally seems to be turning for hedge funds that have struggled to make money in M&A arbitrage trading after 2023 turned out to be the worst year for deals in a decade.

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Mergers and acquisitions are showing signs of revival. The spurt in volume toward the end of last year reflected the strongest level of activity since the beginning of the current rate-hiking cycle, according to Goldman Sachs Group Inc. Adding to the optimism, some event-driven hedge funds surged in December after an abysmal start to 2023, industry tracker Hedge Fund Research said.

Michel Massoud’s Melqart reversed its first-half loss of 4.4% and ended 2023 with a 16% gain. Kite Lake Special Opportunities fund recovered from having lost 5.5% through May to finishing up 10.7%, according to people with knowledge of the matter. CastleKnight, an event-driven equity and credit firm started by Appaloosa Management alum Aaron Weitman, made 16.5%, rebounding from a decline of 6.5% through May, the people said asking not to be identified because the details are private. Representatives for the companies declined to comment.

Event-driven hedge funds tracked by Bloomberg gained 7.2% last year.

An 18-month slump in M&A has hit hedge funds that trade on the spread between a target’s stock and the offer price, and reap a profit if the deals are concluded but risk a precipitous decline if they fall apart. The drop in deal volume shrank trading opportunities and kept spreads tighter especially in the first half of the year. Rising interest rates and uncertainty from the Federal Trade Commission’s crackdown on some mergers added to the squeeze.

Read More: Lina Khan Is Upending Wall Street’s Merger-Arbitrage Playbook

Though deal volume totaled $2.9 trillion last year, the lowest tally since 2013, Bloomberg compiled data show the final three months recorded roughly $869 billion, making it the only quarter that was up year-on-year. The closing of Broadcom Inc.’s takeover of VMware Inc. in November and Pfizer Inc.’s conclusion last month of its $43 billion purchase of Seagen Inc. — both after a series of regulatory hurdles — were among transactions that helped boost returns.

“The M&A corner seems to have been turned towards the end of last year,” said Simon Davies, founder of Sand Grove Capital Management. “Dislocated target valuations, motivated acquirers with strong balance sheets and record levels of dry powder from private equity and private credit create a perfect cocktail for surging M&A activity over the next few years.”

In a research note outlining its outlook for M&A in 2024, Goldman said that as the “higher for longer” rates regime normalizes, and the institutional leveraged loan market becomes increasingly supportive of M&A financing, deal making should gather steam.

But a revival also hinges on a comeback in private equity activity, which has driven about 35% to 38% of overall deals activity in the past five years, Stephan Feldgoise, Goldman’s global co-head of M&A, said in an interview last week. Buyout firms spent 36% less on acquisitions last year, compared with 2022, amid struggles in securing debt financing for big deals and price disagreements with sellers — even when offering hefty premiums.

Read More: Goldman’s Feldgoise Says M&A Comeback Hinges on Private Equity

One hedge fund pointed to the $2.7 trillion of dry powder PE funds are sitting on, with $1 trillion dedicated to buyouts.

Another hedge fund firm noted that the merger arbitrage landscape is now less crowded, with several players shutting down last year. Those that returned capital include Oceanwood Capital Management, Berry Street Capital Management and Aslan House Capital. Several event-driven managers at Millennium Management also left the investing giant.

It may still be too early to rejoice in anticipation of an M&A rebound as many bankers and lawyers remain cautious. Uncertainty over the trajectory of interest rates as well as the potential for more geopolitical tensions and conflicts, and a series of upcoming national elections are among the major risks.

Man Group Plc downgraded its outlook for merger arbitrage to neutral in a research report this week, saying the best may already be over for the strategy after a good run.

But others are optimistic.

“With October boasting the strongest M&A activity in years and November concluding some major deals, merger arbitrage is poised to take center stage in 2024,” said Bantleon portfolio manager Oliver Scharping. “A true renaissance is on the horizon.”

–With assistance from Fareed Sahloul.

(Updates with performance in fourth paragraph. An earlier version corrected the name of a fund in the subhead.)

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