The arbitrage funds rebounded in the third quarter, with Picton Mahoney Fortified Arbitrage Alternative Fund Cl F returning 1.05%, and Picton Mahoney Fortified Arbitrage Plus Alternative Fund Cl F returning 1.75%.
The merger arbitrage strategy led the way in Q3, with a significant number of deals successfully closing. Some recent examples of completed deals are Citrix System, Inc. acquired by Vista Equity Partners (US$14 billion) and Duke Realty Corporation acquired by Prologis, Inc. (US$26 billion). Despite M&A transactions by and large closing on schedule, merger arbitrage spreads remain elevated due to the preponderance of leveraged buyout (“LBO”) deals (historically riskier) and the perception of elevated regulatory risk (strong rhetoric out of the Department of Justice (“DOJ”) and Federal Trade Commission in the U.S.(“FTC”)). It was notable that during the third quarter, the DOJ lost two major court challenges to block deals (UnitedHealth Group’s purchase of Change Healthcare and U.S. Sugar’s deal to buy Imperial Sugar Co.). While having no impact on the portfolio, these serve as important reminders that the success or failure of DOJ/FTC court challenges are ultimately decided by judges who rely on the antitrust laws as written and decades of jurisprudence. Despite the political grandstanding from the antitrust agencies in Washington, we remain cautiously optimistic that the current spread environment is compensating us well for taking on this risk.
For an asset class that’s largely in “run off” mode, special purpose acquisition corporations (“SPACs”) had some notable developments this quarter. The Inflation Reduction Act passed in August and included a last-minute addition of a “buyback tax” aimed at corporations buying back their own shares. As written, the 1% tax would apply to domestic US SPAC redemptions and liquidations occurring after December 31, 2022. Immediately after the announcement, we were able to shift the portfolio to largely mitigate any exposure to this potential tax. Interestingly, because this tax applies at the corporate level (not the shareholder) and it’s unclear whether trust proceeds can be used to pay it, the tax is serving as incentive for SPACs to accelerate their wind ups. In other words, SPACs maturing in Q1 2023 that don’t have a deal in hand may decide to windup early in order to avoid this tax. This improves the rate of return on yield-to-maturity SPACs and we are even seeing non-US domiciled SPACs (not impacted by the buyback tax) decide to wind up early as well.
With wild interest rate volatility in the third quarter, both merger arbitrage and SPACs demonstrated their insensitivity to rising rates. Merger arbitrage spreads are largely short-term in nature, and we price them as a spread over short-term funding costs. SPAC cash-in-trust is held in US treasury bills with a maturity of less than 6 months. All else being equal, rising rates ultimately can result in greater arbitrage returns.
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