Event-DrivenMedium

3 min read · 536 words

What the seat actually does

Event-driven funds trade situations with a defined outcome and a date: a company being acquired, a spin-off, a restructuring, an index change. The question is not what a business is worth but whether a specific thing will happen, and when.

The purest version is merger arbitrage. A company is being bought at a stated price. Its shares trade below that price. Buy them, and if the deal closes you collect the difference; if it breaks you lose considerably more. The spread is the market's price for that risk, and it can be read directly as a probability once the downside is estimated.

• Cash deals — a fixed price, so the position is the target's shares and the risk is completion.
• Share deals — paid in the buyer's stock, so the trade is long the target and short the buyer at the exchange ratio.
• Everything else — spin-offs, tender offers, index inclusions, and the mechanical flows around them.

A day, and where it goes

• Spreads — every live deal, and which ones moved without news, because that is usually somebody knowing something.
• Conditions — the regulatory clearances outstanding and what the timetable now looks like. See a recommended offer.
• Documents — the conditions and the break fee, which is where the actual risk is written down.
• Sizing — because the loss on a broken deal is many times the gain on a completed one.

What it is measured on

• Annualised return on the spread, since a two per cent spread over one month and over one year are not the same trade.
• Deal break experience. One break can undo a year, so the record over many deals is the only meaningful sample.
• Correlation to equities, which is usually low and turns high precisely when deals start failing.
• Whether the losses were the deals expected to be risky. Losing on the ones that looked safe is a different problem.

What it touches on this site

• The transactions — the whole M&A desk, especially hostile takeovers and schemes of arrangement.
• What kills a deal — what kills a deal, which is this seat's actual research.
• The arithmetic — the exchange ratio and the break-fee calculator.
• When it goes wrong — 2016, a deal ended by a rule change nobody priced.

How it goes wrong

• Regulatory risk is not a probability anybody knows. A competition authority or a foreign investment review is a decision, not a distribution.
• Political intervention, which arrives without a timetable.
• Financing falls away, and the buyer's commitment turns out to have been conditional.
• Crowding. Every event fund holds the same twenty deals, so a broken one is sold by everybody at once.

Concepts to master

• The spread is an implied probability, once you estimate where the shares trade if the deal fails.
• The payoff is short-tailed on the upside and long-tailed on the downside — small frequent gains, rare large losses.
• Read the conditions, not the announcement. Which are inside somebody's control and which are not is the whole analysis.
• Time is a cost. A deal that takes twice as long halves the annualised return without anything going wrong.