The second quarter of 2021 can be characterized as “back to business as usual” for the arbitrage strategies.
While there has not been a lot of focus on merger arbitrage compared to special purpose acquisition corporations (SPACs) in our last few quarterly updates, there have been some notable developments in M&A during Q2. The opportunity set, in terms of size of deals and spreads being offered, is as bountiful as we have seen in the last 5 years. We highlighted some of these opportunities on our June 10th update call:
While the potential returns of these opportunities are larger than normal, these spreads are not without risk. Notably, the antitrust regulatory environment in the U.S. is, in some ways, murkier than under the Trump administration. President Biden is yet to appoint a new chair of the U.S. Department of Justice’s Antitrust Division, leaving a major regulatory position unfilled. And in a surprise move in June, 32-year-old Lina Khan, an academic famous for fiercely criticizing “Big Tech”, was appointed as Chair of the Federal Trade Commission. Finally, we have yet to see any evidence of an easier path in China for many big tech deals (a market expectation after the Trump administration made Chinese cooperation challenging).
We currently do not have exposure to any transactions where Amazon, Apple, Facebook or Google (companies which we presume will be the focus of the antitrust investigations) are the acquirers nor have these buyers been a meaningful part of our strategies historically. Nevertheless, the regulatory uncertainty does explain part of the wider spreads we are seeing. On balance, however, we view the current spreads as more than fair compensation for the heightened antitrust oversight we expect. With this landscape, it has been relatively easy to deploy capital in merger arbitrage and our weight across the strategy has increased to approximately 50%.
SPACs were notably quieter this quarter. As we discussed in our last quarterly update, there was a dramatic move in February and March as overheated optimism in the space evaporated. In the second quarter, SPACs continued to trade at more “normal” levels (i.e., price to trust more in line with what we have seen historically). With many units trading at or slightly below $10, there has been little appetite from investors for new SPAC issuance.
While we believe that muted IPO issuance is good thing (at least for the short term to immediate term), we are more focused on the pace of de-SPAC announcements. To help provide context, there are currently over 400 SPACs seeking deals. To reduce the buildup of SPACs, we would need to see 4 or 5 deal announcements per week. Fortunately, that is exactly what we saw in Q2, where an average of 5.3 deals were announced per week. While these deal announcements were largely met with tepid market responses (hence the modest P&L from SPACs this quarter), we are nonetheless pleased that the SPAC market remains very much a viable alternative to companies looking to access the public markets. With very low risk of loss when held to maturity, we believe the SPAC strategy can still generate attractive risk-adjusted returns, as it did from 2014-2019, even without large reactions to deal announcements and we are currently maintaining a significant allocation to the strategy (roughly 50%).
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