After a record-setting 2015, many investors began this year asking, "Can M&A activity sustain this torrid pace?" While there has been some drop-off in total deal value so far this year, according to recent data from Thomson Reuters, investment bankers aren't likely to find themselves twiddling their thumbs anytime soon.
What's been fueling the mergers and acquisitions (M&A) boom? Many companies and sectors have been struggling with the low-growth environment for years now, and are using an acquisition-based strategy to add growth if they can't build it on their own. At the same time, interest rates remain at rock-bottom levels, and many companies have healthier balance sheets and cash positions than they've likely had since the onset of the Great Recession.
All of this has had buyers lining up, and not just those looking to put together the "mega deals" (like Time Warner/Comcast or AB InBev/SABMiller) that get all of the headlines. Deal activity around the world remains strong in the middle market as well.
All of this deal-making has been a particular boon to the hedge funds that focus on what's known as a merger arbitrage strategy. Put simply, these funds look to take positions in the stocks of both buyer and seller when an M&A transaction is announced, seeking to take advantage of potential discounts that can emerge in the stock prices before companies are combined. According to a recent Bloomberg story,¹ these hedge funds have returned approximately 3.4%, on average, from the start of January 2015 through the end of January 2016, handily beating the average hedge fund and the broader equity market over that same time frame.
Will the rest of 2016 bring as many opportunities for these managers to put their strategies and ideas to the test? It's impossible to say with certainty, but the pace of M&A appears poised to remain brisk, at least for the near future. We believe that as long as low-growth conditions persist, acquisitions will remain a key approach for companies looking to grow and expand their reach and holdings. At the same time, merger arbitrage strategies should remain on the radar of investors looking for potential sources of uncorrelated returns.
Adam Patti is CEO of IndexIQ.