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M&A hedge funds seen to hold sparkle into 2007

Date: Thursday, October 26, 2006
Author: Tom Burroughes, Reuters.com

LONDON, Oct 26 (Reuters) - Hedge funds that trade on opportunities from corporate takeovers are likely to perform strongly into 2007 as takeover activity surges, industry executives said.

Merger and acquisition arbitrage funds are seen as likely to be among the hottest hedge fund performers, led by players that spot a bid target months before a public announcement.

These funds -- typically classed in the "event-driven" category -- are likely to be followed by global macro funds, which bet on trends in bond, equity and currency markets, and long/short equity funds.

Merger-based funds are favourites of HSBC Republic, which also positive on macro and equity long/short funds, said Jamie Murray, head of institutional sales and business development at the firm.

"We are very positive about merger arbitrage (funds) ... Overall, a continued stream of corporate activity is going to provide plenty of opportunities," he told Reuters.

Merger arbitrage funds are booming as takeover activity everywhere is fuelled by cash-rich companies and liquid private equity funds. Global deal volumes in the year reached $3 trillion on Oct. 20, the highest level since 2000, according to financial data provider Dealogic.

"Any funds playing M&A should continue to do better than the average (hedge fund), because there are enough catalysts around," Sid Shamnath, an investment manager at Titanium Capital, told Reuters.


In the M&A arena, there are two main types of funds -- those that look for merger targets months in advance of a publicly announced did and those that exploit price shifts once a takeover happens.

Early-mover funds typically make the biggest gains, Shamnath said. "If they made the right call, then ... they should do better than the post-deal guys."

The number of hedge funds trying to make a profit on big M&A deals, such as the recent bid by India's Tata Steel for Anglo-Dutch steelmaker Corus , is large and growing, but there are opportunities stemming from deals among smaller businesses, Shamnath added.

"We have seen good returns in some of the merger arbitrage strategies, and we expect that to continue," Victoria Rock, head of alternative investments, Citigroup Private Bank, told Reuters.

Event-driven funds delivered returns of 9.16 percent in the year to September, just behind convertible arbitrage funds, which led the pack with 10.68 percent, according to the monthly Credit Suisse/Tremont index.

Convertible arbitrage funds trade the different components -- equity, bonds and derivatives -- of convertible bonds, which can be converted into a company's stock.

Another hedge fund strategy that may shine in the next few months is in the global macro segment, Gavyn Davies, chairman of Fulcrum Asset Management and former chief economist at Goldman Sachs, told a recent conference on hedge fund issues.


"A hard landing in the 'States would lead to a much more abrupt change in market behaviour," he said, citing potential events such as a blow-out in credit yield spreads and plunge in the dollar.

The U.S. Treasury bond yield curve, which is currently inverted, could steepen next year if interest rates come down, Davies said. "That could be an opportunity for bond funds and macro funds."

Davies is generally sanguine about long/short equity funds, which he says should continue to make ground on the back of buoyant equity markets into 2007.

Globally, equities remain cheaply valued as prices have not kept pace overall with improved corporate earnings, he said.

Overall, the world's hedge funds, which some researchers estimate hold up to $1.7 trillion in assets, hit a bump in May when stock markets pulled back in the face of concerns about rising inflation and interest rates.

So far in 2006, hedge funds have chalked up average returns of 7.64 percent, compared with 7.5 percent for the whole of last year, 9.5 percent in 2004 and about 15.5 percent in 2003.

If hedge funds manage to outperform equities in 2006, it will be for the first time since 2002, when they returned an average of around 3.0 percent versus losses of 19.5 percent for the benchmark MSCI index <.MSCIWD> of world stocks.

Among the poorer performers this year have been managed futures funds. They are down by 0.13 percent since the start of 2006, according to Credit Suisse/Tremont. Managed futures bet on market trends, employing the use of computer models.

There may be more opportunities for distressed debt funds as bankruptcies rise, but they are unlikely to catch fire until at least 12 months from now, because corporate default rates remain at historically low levels, executives said.

These funds trade securities of companies in financial trouble, for which prices have collapsed but the chance of repayment is seen as high.