Hedge Funds Betting on Deals See Best Start to a Year in Decades

(Bloomberg) -- The feverish market for corporate marriages has created a fertile hunting ground for hedge funds that are raking in bumper profits from betting on the success and failure of big-ticket deals.

So called event-driven funds that wager on mergers, acquisitions and other company changes gained an average 7.6% during the first quarter, their best start to a year since 1993. They also had a better run than any other broad hedge-fund strategy, according to data from Hedge Fund Research Inc.

Returns are being fueled by the busiest M&A market ever as optimism about global vaccine programs and faster economic growth accelerates dealmaking. That’s spurred companies to strike $1.6 trillion of deals this year, according to data compiled by Bloomberg, up 87% from a year earlier and the most for any corresponding period on record.

“Strong global merger volumes, increased regulatory uncertainty, coupled with a clear out of capital in March 2020 particularly from quant funds, in addition to the distraction of SPACs, are all helping to keep M&A spreads wide,” said Jamie Sherman, co-chief investment officer at Kite Lake Capital Management.

Event-driven hedge funds such as Kite Lake bet that the share price of a target company will rise toward the offer price as a deal nears completion. Uncertain markets keep that gap or spread wider for longer as investors fear the deal may fall apart, presenting the funds with trading opportunities.

What’s also boosting such funds is the unusually elevated levels of increased offers for approaches and agreed deals as frothy markets push even higher. Further tail winds are coming from a pickup in hostile and competitive situations, along with bouts of stakeholder pressure to improve deal terms.

Bidders have raised their prices in about 263 deals this year compared with 176 during the same period in 2020, according to data compiled by Bloomberg. Cisco Systems Inc. lifted its offer for Acacia Communications Inc. by more than 70% in January, while Kaz Minerals Plc won investors’ support to go private only after raising its bid twice.

Biggest Flows

The twists and turns are paying off for hedge funds betting on the fate of a deal.

Kite Lake, which manages $1.65 billion, gained 7.6% in its flagship fund during the first four months of the year, while Michel Massoud’s $1.7 billion Melqart Asset Management returned 14.8%, according to people familiar with the investments. Sand Grove Capital Management, with just under $2 billion of assets, made 18% in the period.

Their gains are rewarding investors who bought into the strategy despite the overall industry suffering outflows last year. Event-driven hedge funds attracted nearly $4 billion, the most for any strategy, while their peers saw $59 billion of net withdrawals, according to data compiled by eVestment.

With an influx of just $1.4 billion during the first quarter, event-driven flows had a more tepid start this year. But some prominent players are already sensing opportunities from elevated deal making. Massoud’s Melqart last month reopened to investors for the first time in three years to raise up to $500 million.

“The mood within board rooms remains constructive,” said Massimo Stabilini, a former Paulson & Co. executive who runs hedge fund Sinclair Capital. “Ground remains very fertile with record number of deals signed after a dry 2020 and lots of willing buyers.”

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