Is merger arb the right place to be in?
I’ve seen so many L/S funds struggling and the news on TWTR has cast some light on looking at these event driven funds. I’ve only spoken to 1 or 2 people in industry about this but it seems like a pretty well performing strategy. Why don’t more banking people explore this route? Am currently a l/s analyst musing whether the transition is possible or am I missing something?
Bump
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Thanks. Feels like the argument against it is based primarily on 1) probably won’t be able to raise a fund on the strategy alone which I agree and 2) it becoming more passive because you can argue that it’s largely risk premium. Is that entirely true though? I thought the idea was that many of these situations are all unique so it’s hard to automate because you need human judgement to select which deals you want to participate in since the amount you can lose if you get it wrong is immense
On another point - don’t you think the repeatability and risk premium nature of it makes the strategy ‘easier’ since there is a very straightforward way of making money? I’m guessing you left merger arb for l/s?
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Before anyone decides to work in merger arb, I'd recommend meeting enough people across the industry to get a proper sense of the stereotypical arb personality type. They have a certain used car salesman quality to them. You either like hanging around them or you don't.
totally agreed. the ones that i met are a bit shady
me and my friends think they trade on insider info, or least the ones that i met
It's a really delicate balance they like to walk. Almost all of the old heads you'll meet in the trade 100% made their gains back in the late 90s and early 00s on insider info. The execs back then just weren't trained by lawyers to keep their mouth shut, and investment bankers were much more loose lipped as well. Over the past 15 or so years things have really tightened up. So instead of insider info, they try to pressure box people into just giving a vague indication. I remember watching like 10 arbs corner some minor government employee in one of the state health departments that was reviewing an insurance merger, and just trying to sweat them out for an expected timeline or the potential for divestitures. You could have spit in those arbs faces and told them to fuck off but they would've kept saying shit like "My PM is worried this could last until next year, do you think that's a fair concern?"
Your edge often needs to be in the legal/regulatory arena. And even then, decent knowledge in those areas isn't enough because these situations can boil down to a very narrow question about how a particular judge or regulator will decide something. Examples:
1. Twitter - you can read the merger agreement and know Delaware case law, and see that Elon's claims about bots won't amount to a material adverse change. But there's still the question of whether the judge would grant specific performance or just grant Twitter the $1b break fee. Even dedicated legal experts split on that question. But let's say you came out on the right side of that one (i.e. judge will grant SP) and then last week you have the latest curveball of a possible CFIUS review of the deal. Which is more of a question of politics than law, so now you need to be a beltway insider too.
2. KCS deal last year, with CP and CN fighting over it - you'd need not just a good understanding of antitrust law but also the specific question of how the Surface Transportation Board might look at that particular deal. And that involves reading about 100 different letters submitted to the STB by interested parties, talking about the impact of the deal if CP gets it vs. CN. And then after reading those letters, you'd assume CN gets the higher bid . . but you'd also have to know that Joe Biden is about to issue an executive order on rail competition that indirectly favors CP, and you'd have to know whether or not the STB will be swayed by that order since it only hints at things and doesn't in any way say they'll have to give it to CP. Very political decision in the end.
3. Failed Covid deals like Taubman/Simon and L Brands/Sycamore - caselaw was very convincing that these deals would not be breakable with a MAC clause, and yet to the shock of many the buyers were able to walk away from the deals (and in the case of Simon get a much lower price). You'd have to know not just the law, but that the GCs of these selling firms were massive sissies who wouldn't stand up for shareholders.
Point being, a lot of these things turn on discussions among people in power that no outside investor is going to be privy to. It can still be a fun and lucrative field but knowledge of finance/M&A is of little relevance to alpha because all of the finance/M&A points are quickly baked into the price. As the arb you need to have a view on these much thornier, often un-answerable questions.
This is very interesting. I’d be curious to know who are some of the big players who are respected in the space? Farallon, Davidson Kempner come to mind but that’s as much as I know when it comes to large funds. Thank you
Great explanation - thank you
If you think merger arb is easy, it's a clear case of "you don't know what you don't know'".
Let's not be naive, we are in the 2020s and any new alpha opportunity gets crowded away super quickly, look at what's happened with index arb recently. Merger arb went thu the same dynamic 20 years ago. You could not be more wrong.
I think it appears easy because there’s a systematic process where you’re looking at deals continuously and it’s easier to decipher what’s in the price or what’s not and then take a view. I’ve anecdotally found merger arb returns to be much more consistent than l/s across multiple funds
Merger arb certainly is not easy, but the way I thought about it is that you're basically doing the work that a lot of other people either get wrong and/or don't really do.
For example, I programmed a screener for merger-arb risk. A ton of the data we were getting from either FactSet or Bloomberg was just blatantly wrong or missing because other people don't read documents correctly. It's amazing how often things like this occurs and how just having knowledge like that in a centralized place can give you an information advantage. This is work that very few others are realistically doing, and although it's easy to say that "any new alpha opportunity gets crowded away super easily," I think there are generally ways to get alpha that very few are genuinely considering since many of them require a lot of person-hours and involve gathering information that may or may not be wrong or may or may not be centrally organized.
I won't disagree with the idea that new ideas for alpha quickly get crowded: this is more true than ever and only going to become more true as the years continue. But at the same time, I think that there are a lot of crevices and parts of the market in which people are not simply doing really mundane basic work since it's boring and takes a lot of time.
What kind of data and how did you source it?
All kinds and mostly by reading DMAs directly
There are 2000 stocks to look at doing regular L/S on the Russell 2000. 500 stocks in the SP500.
If you are doing merger arb, you have what, half a dozen sitiations at a time where EVERYONE that focuses on the strategy is looking into.
I'm really hard pressed to think of any strategy/asset class as crowded as this one. By definition, the oppotunity set is extremely limited, and it has billions of dollars chasing after it.
Err. Equity L/S? Let’s be real. In many places, you’re a sector specialist covering large cap names. And you’re probably not covering more than 30 names in depth at a time. Everyone is looking at these names too.
At least with merger arb there seems to be a defined path and process showing you how you can make money. With L/S - you can pretend you have a process but people are all doing the same shit anyway too. And this time you don’t have that clear path to profit. it’s probably easier to blow up in merger arb though because if a deal breaks, you’re probably done
The screener I was building looked back at pretty much every deal we could find historically. Getting that information for previous deals that closed was useful for our process rather than just being a means to pick among the existing opportunities.
This above basically hits the nail on the head. You have to have something that is defined and build consistently on that. And that's what that screener is a part of. At my shop, we have basically a series of specialists looking at large cap names, and they are not going to realistically be able to generate something that is meaningfully to different from what others in the market are thinking.
My job in part with another analyst who specifically works on merger arb was to build something that would work through that process and build further on what had been done before. It's not just ~20 deals we're looking at here, it's thousands and that's where you can get that information edge by looking through old DMAs.
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