Hedge funds specializing in bets on mergers and acquisitions are starting to see investors withdraw funds, prompting them to take a more cautious approach after being caught out by more than 500 corporate deals globally failing this year.
Part of a broader industry strategy aimed at making money from major corporate events, these deal-focused funds gained an average 13 percent in 2013, their best year since 2010, which helped them lure in a net $10 billion in new cash through August this year, data from industry tracker Eurekahedge showed.
But a series of failed deals, including the collapse of a $55 billion tie-up between UK drugmaker Shire (SHP.L) and U.S. peer AbbVie (ABBV.N), has led to losses for some of the world's biggest proponents of the strategy, with investors pulling out $3.3 billion in the last two months alone.
"The AbbVie/Shire break, in particular, has led to a far reaching de-risking exercise for many funds," said Pierre di Maria, head of event driven strategy at Cheyne Capital.
"Those funds have reduced their gross exposure to deals in order to lessen their overall risk and to be able to face any upcoming redemptions," he added.
The year had started well as a combination of low interest rates, weak global economic growth and companies flush with cash boosted M&A deals. As of Nov. 10, deal volume was up 47 percent year-on-year to $2.9 trillion, Thomson Reuters data showed.
However, at the same time, deals worth $580 billion have been pulled, the most since 2008, trapping many funds on the wrong side of the so called "merger arbitrage" trade, which aims to eke out returns by capturing the spread between a company's market price and the price at which it may be acquired.
BOLD BETS
The recent blow from AbbVie pulling its bid for Shire -- after the U.S. government moved to curb deals designed to cut taxes -- has led to losses for the likes of Paulson & Co, Tyrus Capital and Elliott Management.
"The deal breaks have made managers more conscious of political risk and intervention within the M&A space," said Jeff Holland, a managing director at hedge fund investor Liongate Capital Management.
While the Shire deal was only the fourth-biggest deal to fall apart this year, behind the abandoned 70 billion pounds ($110.4 billion) bid by Pfizer (PFE.N) for AstraZeneca (AZN.L) in May, many funds had bet big on its success.
That concentration was reflected in Shire's share price fall when the deal broke up -- 22 percent, about twice that of AstraZeneca when it went through a similar situation.
Following the Shire deal collapse, merger arbitrage spreads, or the difference between a company's share price and the price at which it may be bought, on other deals widened by 2.5 percent on average as a number of hedge funds liquidated positions, presenting an investment opportunity for some, said Di Maria of Cheyne Capital, adding he had nearly doubled the size of his merger arbitrage portfolio.
DEEP LOSSES
Hedge fund manager John Paulson, who invested 1.44 billion pounds in Shire on Oct. 14, saw his Advantage fund lose 13.6 percent in October, according to an investor, while Elliott Associates said it may take legal action against AbbVie for scuttling the deal and losses.
Another fund to take a hit was Tyrus Capital, which bet both on Shire's share price rising and AbbVie's share price falling. The $1.4 billion Tyrus Capital Event Fund ended October down about 6.5 percent, fund data obtained by Reuters showed.
"This has raised questions about portfolio concentration of hedge funds on some risky M&A deals," said Philippe Ferreira, head of research at Lyxor Asset Management.
"We are advising investors having a strong exposure to event driven to diversify their portfolios," he added.
An index from Eurekahedge tracking event-driven funds fell 2.1 percent in October, its biggest monthly decline since 2011, highlighting their poor recent performance.
Investors keen to capture merger arbitrage returns, which are less correlated to other strategies, but reluctant to shoulder the risk of losses from another big deal collapse, may also consider passive funds, which buy and sell stocks involved in deals but tend to be more diversified.
Such a strategy has already outperformed the average active event driven hedge fund manager this year. The IQ Merger Arbitrage ETF, for example, has returned 3.4 percent this year and was flat in October.
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