The Picton Mahoney Fortified Arbitrage Alternative Fund Cl F returned 1.27%, and Picton Mahoney Fortified Arbitrage Plus Alternative Fund Cl F returned 1.93% in the fourth quarter of 2022.
The funds benefited from higher interest rates in multiple ways this quarter. On the merger arbitrage side, we always quote spreads over short-term interest rates (U.S. Fed Funds rate). This is because the vast majority of merger arbitrage investors (i.e. the marginal buyers of M&A targets) use leverage that they fund overnight at these rates (plus a small spread to the prime broker). One would never take M&A risk for 5% if the risk-free rate is 5%; we always require a spread over the Fed Funds Rate to compensate us for risk. We have seen this at play in recent quarters as “vanilla” arbitrage spreads have risen from approximately 4-5% to 7-8% as the Fed Funds Rate increases from 0% to 4%.
On top of this rise in interest rates, we’ve discussed for several quarters now that spreads are wider than typical because of the renewed focus of the Department of Justice (“DOJ”) and Federal Trade Commission in the U.S.(“FTC”) on challenging mergers as anti-competition. This continues to be the case as we await the resolution of many of these mergers, with the acquisition of Activision Blizzard by Microsoft being at the top of the list. We also saw a non-US regulatory issue give rise indirectly to a deal break as DuPont de Nemours Inc. (“DuPont”) terminated its acquisition of Rogers Corporation after failing to secure a Chinese antitrust approval in a timely manner. The fact that DuPont didn’t extend the merger agreement to allow extra time to complete the review was a surprise to us and the market, and cost us about 50bps of performance in the quarter (for the unlevered fund). We fully exited the position on the day the deal broke.
For the first time in a long time, there have been some large and interesting Canadian M&As for us to focus on. The merger of Shaw Communications and Rogers Communications has garnered a lot of headlines and we were pleased to see a partial victory by the companies at the end of the quarter. We hope for a further victory this month as we await the results of the appeal by the Competition Bureau. Less newsworthy but perhaps more interesting to Canadian arbitrage players is the purchase of Summit Industrial Income REIT by Dream Industrial and GIC (the Singapore government’s investment arm). This C$6 billion deal has a structure that is very tax inefficient for non-Canadian investors to hold. The resulting supply/demand imbalance has arguably led to an excessively wide spread.
Back to interest rates but shifting gears to special purpose acquisition corporations (“SPACs”), we have seen cash in trust accrue at close to the Fed Funds Rate in the fourth quarter as expected. The cash in trust is invested in short-term US treasury bills, money market funds, or interest-bearing bank accounts. This is important as, similar to merger arbitrage, our expected returns increase when interest rates increase. While the asset class is largely in “run off”, we did get some good news late in the quarter as the Internal Revenue Service clarified that SPAC liquidations would not be subject to the 1% share buyback tax.
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