Hedge funds

The so-called death of event-driven investing

The activists’ playbook for juicing shareholder returns is not working, says Stephen Foley

“The Last Word

[march 6, 2016] by: Stephen Foley

When Daniel Loeb, the activist investor, addressed the annual meeting of investors in Third Point, his hedge fund, last month, he opened with an amusing slide. It showed a bloodied and battered cartoon version of himself staggering towards a tombstone engraved with the message “RIP event-driven investing, 2015”.

Lest anyone think Third Point is predicting the demise of one of the most lucrative hedge fund strategies of the past few years, the slide was titled “The so-called death of event-driven investing”. But even Mr Loeb admitted the industry is at an inflection point.

Funds in the event-driven category are a heterogeneous bunch, but one way or another they aim to profit from corporate moves such as financial restructurings or mergers and acquisitions. As markets shifted in the past year, many funds found themselves betting on the wrong kinds of corporate moves. Event-driven strategies that worked in an equity bull market are not doing so now.

This is particularly the case for the brand of activism with which Mr Loeb and rivals such as Bill Ackman and Carl Icahn have terrorised corporate managements for years. These attacks look like being a lot less widespread in the future.

The proximate cause is the string of terrible results from activism’s leading lights. Last year, Mr Loeb’s equity investments lost 3 per cent, but the truly awful headline numbers came from David Einhorn’s Greenlight Capital and Mr Ackman’s Pershing Square, both of which were down 20 per cent.

A more important factor: the fundamentals have shifted.

Since the middle of last year, the outlook for the global economy has soured considerably. Earnings for US companies, in particular, are contracting after years of artificial growth from share buybacks. Even if one does not accept a gloomy economic prognosis, one cannot deny that corporate borrowing costs have risen and credit markets have become more volatile and unpredictable.

The activists’ playbook for juicing shareholder returns — lever up a company’s balance sheet and return cash to investors — simply does not work in the current environment, and long-term investors are revolting. One of Mr Loeb’s investment rules is “no financial-engineering investments in spooked markets”, and the likes of Larry Fink, chief executive of BlackRock, the world’s largest asset manager, have issued increasingly strident warnings against buybacks and even dividends.

It is a sentiment echoed by investors up and down the market. Jonathan Coleman, small-cap portfolio manager at Janus Capital, told me recently he has made balance-sheet strength a key demand at meetings with his portfolio companies over the past few months. Credit markets are more uncertain and refinancing a mountain of debt is not likely to be as easy in the future as it has been in the era of quantitative easing by the Federal Reserve. “There is nothing that can do as much damage to the equity as a risky balance sheet,” he said.

It is hard not to read all these signs from the financial markets and from the investment community as the early warnings of a turn in the economic cycle, but of course the timing of the next downturn is uncertain and there could still be another leg of growth between now and an eventual recession.

Event-driven fund investors are not waiting to find out; they are already in a period of retrenchment. SkyBridge Capital, a powerful fund of hedge funds company, said it took $1bn away from event-driven managers including Mr Loeb, Barry Rosenstein of Jana Partners and John Paulson in the final months of last year. HFR, the data provider, recorded $2.2bn in outflows from the $745bn event-driven hedge fund industry in the fourth quarter of last year and the bleeding appears to have accelerated in 2016.

Investors in event-driven hedge funds lost 4.7 per cent last year, according to HFR, so it is little wonder that they are reassessing their commitment to the strategy.

Mr Loeb told his investors that a shake-out of smaller funds will create more equity market opportunities for seasoned managers, and he has shifted his focus to other kinds of corporate events around which to invest. Distress in some sectors, such as energy, could throw up lucrative opportunities. He is also talking up Third Point’s credit portfolio, which is larger than its more famous equities arm.

Event-driven investing is not dead, it will just morph. Even activism may have a cycle or two in it yet. But it seems a safe bet that the Loebs and Ackmans of the world will be less loud this year and for the foreseeable future.

Stephen Foley is the FT’s US investment correspondent