The collapse of the $30 billion deal between Aon and Willis Towers Watson in late July was enough to prompt a selloff in merger arbitrage and create a big opportunity for long-term investors.
According to GMO, the weighted average gross spread, a signal of potentially attractive future returns, in the asset manager’s event-driven portfolio increased to 11.3 percent in early August. That compares to a median spread of 5.9 percent among the 1,700 deals that GMO’s event-driven team has invested in since November 2014. Even though GMO stressed that markets have since calmed down, spreads remain high in the top quartile of deals. GMO’s event-driven strategies are primarily invested in merger arbitrage transactions. Merger arb managers generate returns by buying the targeted company and profiting when its price rises to meet the terms of the acquisition.
“The merger arbitrage world isn’t fundamentally scarier today than it was just a few weeks ago, but current spreads suggest it is,” according to a recent report from GMO on the opportunities in the strategy. “We believe investors with a long-term mindset should be focusing closely on merger arbitrage today.”
GMO isn’t the only manager seeing opportunities in merger arb. George Kellner, who founded Kellner Capital 40 years ago, said he’s more bullish than he’s been in decades. Taconic Capital Advisors, the event-driven and multi-strategy hedge fund firm, recently raised money for a new vehicle to take advantage of the current robust environment in merger arbitrage, according to a person familiar with the fund raise.
The asset manager had been bullish before the Aon-Willis Towers Watson deal imploded. Money normally chasing merger arb deals had been pouring into hot SPACs, or Special Purpose Acquisition Companies, instead. That left a void of money dedicated to merger arbitrage, particularly given the record number of companies merging and doing deals with one another, according to GMO.
Then the deal between Aon and WTW, which would have created the world’s largest insurance brokerage, fell through on U.S. anti-trust concerns. There’s always a risk that deals don’t go through, but when a big one breaks, it can take a toll.
“Because most merger arbitrage investors are human, they become less confident [if they made a wrong decision on the Aon-WTW deal],” Sam Klar, one of two portfolio managers of GMO’s event-driven strategy, told II.
“As they become less confident, they are often in a position where they say, ‘I should go sell some shares in the market,’” Klar said. “When everyone does that, it can lead to spreads widening a great deal.”
The widening spread is a result of normal “technical reactions,” stressed Klar. But investors with “fundamental judgments” should realize that the merger arbitrage space still presents huge investment potential, he said.