Our arbitrage funds were modestly positive in Q1, protecting capital in a difficult environment for stocks and bonds.
The merger arbitrage portfolio benefitted from the closing of three large marquee deals in the quarter: AMD’s acquisition of Xilinx Inc. (US$50 billion), IHS Markit Ltd. being acquired by S&P Global (US$50 billion), and Microsoft Corporation’s purchase of Nuance Communications Inc. (US$17 billion). The rest of the merger and arbitrage (“M&A”) book was largely well behaved despite the equity market volatility of the quarter with no dramatic moves or deal breaks.
The current North American M&A investable universe is dominated by two types of deals: longer-dated strategic deals with less-than-straightforward regulatory paths (e.g. Activision Blizzard Inc., Mandiant Inc., First Horizon Corporation) and leveraged buyouts (e.g. Anaplan Inc., Citrix Systems Inc., Intertape Polymer Group Inc.). While the spreads on these deals are wider than normal and offer attractive risk/return, we are being judicious in the use of our risk budget and keeping exposures relatively small. We are extremely aware that leveraged buyouts in particular have a long history of disappointing exactly when you don’t want them to (March 2020 and the 2008 financial crisis). For that reason, they have always been deemphasized in the portfolio.
At the lowest end of our risk spectrum, we have been very active in buying special purpose acquisition corporations (“SPAC”) common shares with attractive yields to maturity. Ignoring any upside from deal optionality, there are many SPAC common shares offering yields of 2.5% to 3% above short-term interest rates. Importantly, as short-term rates increase, these will likely benefit alongside (i.e. they generally act like floating rate bonds). There is also a reasonable potential for many of these SPACs to close a deal sooner than their maturity date, further enhancing yields. The lack of interest-rate sensitivity in this trade was apparent in the quarter as SPAC common shares remained very stable while the bond market was in turmoil.
Despite the attractive yields available in SPAC common shares, not all is rosy in SPAC land. In perhaps the least surprising news of 2022, the market has come to the realization that we probably don’t need 600+ SPACs and that many of these sponsors will likely struggle to successfully close a business combination before their deadline. While this has minimal impact on SPAC common (a holder will receive $10 plus interest at wind-up), SPAC warrants will expire worthless if the SPAC doesn’t close a deal. Additionally, the performance of 2020- and 2021-vintage former SPACs has been largely disappointing (although in line with regular-way IPOs of the same era). The combination of these two forces has resulted in a very weak market for SPAC warrants; they were our largest detractor from performance in the quarter (approximately 30bps in the Picton Mahoney Fortified Arbitrage Alternative Fund). Our remaining weight is very small at approximately 45bps (in the Picton Mahoney Fortified Arbitrage Alternative Fund).
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