Event Driven Investing – A Review of the State of the Art
One investment strategy we at Blackhawk Partners have been particularly been involved in over the last few years is “Event Driven Investing”.
Event-driven investing is an investing strategy that seeks to exploit pricing inefficiencies that may occur before or after a corporate event, such as a bankruptcy, merger, acquisition or spinoff.
To illustrate, consider what happens in the case of a potential acquisition. When a company signals its intent to buy another company, the stock price of the company to be acquired typically rises. However, it usually remains somewhere below the acquisition price—a discount that reflects the market’s uncertainty about whether the acquisition will truly occur.
That’s when we enter the picture. We will analyze the potential acquisition—looking at the reason for the acquisition, the terms of the acquisition and any regulatory issues (such as antitrust laws)—and determine the likelihood of the acquisition actually occurring. If it seems likely that the deal will close, we will purchase the stock of the company to be acquired, and sell it after the acquisition, when its price has risen to the acquisition price (or greater).
We also use distressed-investing strategies as part of our overall strategy to make money. Distressed securities – for those not familiar with the term – are corporate bonds, bank debt and trade claims—of companies that are in some sort of distress, such as bankruptcy. We also use this class of securities precisely because event-driven and distressed investing strategies are usually complementary. In fact, event-driven investing tends to work best when the economy is performing well (because this is when corporate activity is highest). Distressed investing, on the other hand, tends to work best when the economy is performing poorly (because this is when companies tend to become distressed).
In summary, we have the ability to go long or short, because things can also get expensive, as well as cheap. And we can invest in credit or equities, since one or the other may be more attractive, depending on circumstances.
By investing in a smart way and by not taking market exposure – by hedging away any unwanted exposure -, the strategy relies on our managers making the right calls, and not on the markets going up or down. That’s in one simple way of generating superior risk adjusted returns.
And of course we always look for the next “black swans” in the horizon though we don’t spend a lot of time forecasting what the black swans might be. Instead we look at “pressure points” in asset classes that have “gotten substantially out of whack,” and buy the cheapest protection possible, from puts and calls on stock indices to options on interest rates and currencies.
Of course, it takes a lot of diligence for ordinary investors to trade puts and calls on a regular basis. Those trades can be especially tough to swallow when markets are going up and options are expiring worthless.
We are though prepared to wait a very long time to get a black swan as we do happen to believe that more panic is looming.
Caution: Event-driven investing strategies are typically used only by large institutional investors and not retail investors. Caution is to be used when investing in such securities since traditional equity investors, including managers of equity mutual funds, do not have the expertise necessary to analyze many corporate events. But also that’s exactly how event-driven investors at large make money.