The long and short of it
Megadeals like Shire can turn arbitrage into arbitragedy. U.S. drugmaker AbbVie’s retreat from a $55 billion takeover of its European rival has hit hedge fund titans including John Paulson and Paul Singer. The setback caps a dismal run for merger arbitrageurs – and shows that the most tempting deals can carry the biggest risks.
Getting the full picture on Shire is tricky. It’s hard to see if firms have hedged their positions, or amplified them with leverage, or indeed, exactly what they paid on the way in. Nor is Shire’s fate clear yet. But the paper losses look awful. Paulson’s firm had nearly 28.5 million shares, including some derivatives. Shire shares have fallen over 15 pounds apiece. There goes almost 450 million pounds ($719 million).
“Risk arb” sounds buccaneering but should be dull. You buy stock a smidgen below an agreed offer price from impatient money managers and, customarily, hedge this by shorting the buyer’s shares. As hedge fund strategies go, it’s hardly breaking the Bank of England or fighting corporate fraudsters.
And yet the sector has struggled, even before the latest blowup. Credit Suisse’s risk arbitrage index is up 1.5 percent in one year, and 14 percent over five. The S&P 500 managed 20 and 107 percent. Sure, maybe you take less risk, and maybe you enjoy “uncorrelated” returns. But those aren’t stats you want side-by-side when you pitch to the family office of Silicon Valley’s latest billionaire.
What gives? One possible answer lies in the dearth of M&A, at least up until this year. When investors chase fewer deals, that pushes stocks closer to the official offer prices. In turn, that lowers returns.
Another problem is that bigger deals are more liquid, and so easier to bet on. But the largest acquisitions also bring the most unpredictable risks. It’s one thing to wager that the union of two widget-makers will dodge an in-depth Brussels probe. It’s another to correctly predict that Canada would say “hands off our potash,” that phone-hacking would stop News Corp buying BSkyB, or that Obama’s fightback on tax would have real teeth.