At GAM Investments’ Weekly Investment Meeting held on 17 April 2019 the speakers were Michael Biggs, who provided an interesting update on the global macro environment, and Roberto Bottoli, who discussed the latest developments in the merger arbitrage space.
One of the more interesting parts of the macro environment to keep an eye on has been the prospects for a rebound in both China and the euro area. If these rebounds transpire, we believe it should enable global growth to hold up and be positive for risky assets.
Lending in China, which was strong in January, moderated somewhat in February but was again strong in March, which we believe should help to push up domestic demand. The fall in interest rates confirms policymakers are easing and the credit impulse should make further gains from here, in our view. In the past it has simply been a matter of time before a pick-up in lending has fed into economy activity. We have already seen some additional growth indicators, such as improved car sales, while Purchasing Managers’ Index (PMI) levels have ticked up. Property sales have remained weak, but we anticipate an improvement going forward.
One area which has disappointed in China has been imports. We want Chinese imports to be strong so the rest of the world’s exports pick up. We suspect the current softness may in part be linked to a VAT cut which came into effect at the start of April.
Data from the euro area has been more mixed. If the shocks we have previously discussed – emissions regulations for the auto sector and last autumn’s low Rhine River water levels – start to unwind we believe we should get a rebound in industrial production (IP). IP growth in the early part of the year points to GDP growth of 0.3% to 0.4% for Q1, even if IP falls by 1% in March. The European Central Bank (ECB) lending survey suggests credit conditions have tightened modestly.
Retail sales have been stronger than expected. However the manufacturing component remains weak, with German orders declining. If this does pick up we will have increasing confidence in the euro area.
The aim of our singular investment approach is to deliver stable, predictable returns over time, adopting a market- neutral philosophy and structure. In this context, stocks can be viewed as bond substitutes, and the carry on the fund derives from the spread between the prevailing share price of a company, which is to be acquired, and the takeover price – the arbitrage spread.
We invest in three main categories of risk arbitrage opportunities: mergers & acquisitions (M&A) (our main focus), spin-offs and indices reviews. The latter two components are primarily utilised to tactically aid portfolio diversification, alpha generation and to help mitigate instances of spread tightening.
We are heavily exposed to mid-and small-cap companies as we have the potential to earn a premium from these positions. These are the least crowded parts of the market, where, in our opinion, it is possible to achieve higher returns for the same level of risk and help to differentiate our strategy from competitor offerings. Furthermore, focusing on companies in this segment of the market-cap scale can remove much of the antitrust risk, since such deals do not typically alter the competitive structure of a specific market. The lower funding risk associated with mid and small caps also makes this part of the market, in our view, a ‘sweet spot’ of the M&A landscape.
We also want to be involved in quality stories – the safest situations in the arbitrage market. We will only invest in a company where the deal has been announced and is a ‘friendly’ deal, and have a strong preference for certain types of arbitrage spreads. While drawdowns can result from the termination of deals or spread widening (eg associated with politically based antitrust delays and determinations reflecting Sino-US trade tensions) from time to time, we strive to minimise the number and effect of these.
In terms of the current environment, the commencement of trade talks has improved sentiment, despite the lack of a resolution. This is important to us as a vibrant M&A market enhances diversification opportunities. Year-to-date M&A volumes are encouraging but transaction numbers are a little lighter than this would normally imply. Volumes have been driven by multi-billion deals, including the first ‘non-bail out’ mega merger in the US banking sector, between US oil majors and two mergers in the payments-processing space. We are also witnessing some evidence of a normalisation of credit spreads from the wider levels witnessed in the second half of 2018.
Looking ahead, we continue to draw encouragement from the low funding cost of potential transactions and the continued vibrancy of cross-border M&A activity. Meanwhile, a continuation of low market volatility would maintain the prevailing benign environment, potentially allowing us to judiciously apply leverage with a view to enhancing returns.
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Source: GAM unless otherwise stated.
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