The Vertex Arbitrage Fund (F) returned 2.50% in the first quarter, its best quarterly performance since inception. W ith recent market volatility at unsettling levels, we thought it was a good time to showcase two positions in the portfolio and how they helped achieve our objective for positive returns, independent of the market.
Corus Entertainmentannounced the asset purchase ofShaw Mediafrom Shaw Communications in January. This deal is as a good illustration of our active approach to M&A investing; we asses all levels of the capital structure and deal parameters to determine the best risk/reward opportunity. Often, it is the less obvious investment that yields a superior result.
Despite some late intervention by an activist investor, we considered this to be a simple deal as the various regulators would continue to consider the asset to be controlled by the Shaw family. We estimated the probability of the acquisition closing at well over 95%. While there was no direct arbitrage trade between the two entities (the transaction was the sale of an asset as opposed to an entire corporate entity), there were two related arbitrage trades being driven by the same underlying event (the successful completion of the asset purchase) that we could assess for a superior risk/reward:
The first was to be long (buy) the subscription receipts (issued by Corus as part of the financing for the deal) versus being short (sell) the common equity (the receipts turn into equity upon completion of the asset purchase). While it varied throughout the term of the deal, this trade offered approximately 1 unit of return for 10 units of risk.
A second arbitrage opportunity presented itself in Corus bonds (4.25% of 2020, a $550mm issue) that were being refinanced as part of the transaction. For the same underlying risk factor, these bonds offered 1 unit of return for 5 units of risk.
Needless to say, we favoured the bonds over the receipts and the resulting position was one of our largest winners in the quarter.
Marriottannounced their $15 Billion acquisition ofStarwood Hotelsback in October. A highly strategic acquisition with moderate regulatory risk, the deal offered an arbitrage return in the neighborhood of 5-7% annualized. This relatively straightforward transaction became much more exciting in March with the emergence of a competing bidder in Anbang Insurance Group (a Chinese insurance company with a penchant for acquiring hotel assets). After several iterations of bids from Anbang, Marriott responded with a materially improved offer and carried the day. Importantly, we were able to add to the position while still earning a positive return to the improved Marriott offer (it would be more typical in a bidding war to have to pay through the terms for the chance of another improved deal). While bidding wars are rare and we certainly never expect them, its a nice reminder of some of the unexpectedly positive things that can happen in the arbitrage universe.
Though we are highlighting these two nice wins, the bulk of the funds performance was generated more broadly. Each situation in the portfolio differs but shares the same source of return: a spread narrowing towards deal completion. In our last quarterly letter, we emphasized that merger arbitrage spreads were anomalously attractive. As spreads have tightened up (as deals closed), the fund has reaped the rewards. This behaviour is independent of volatility in the markets, which is how the portfolio generated positive returns in each month of the first quarter.
Looking forward, spreads remain attractive in the 5-7% (per annum) range and there continues to be good deal flow in the U.S.
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