December 29, 2021 – According to J.P. Morgan, merger arbitrage has been the most consistent performing alternative investment strategy since 2011.
Over the past eleven years, merger arbitrage has been the only hedge fund investment strategy to produce positive returns every year.
Source: J.P Morgan, HFRI
2021 was another year of positive performance, with the S&P Merger Arbitrage Index Total Return producing a 6.0% return year-to-date, while the HFRI merger arbitrage index gained 10.1%.
This year, U.S. mergers and acquisitions activity set a new record by deal amount and dollars spent.
Source: PwC analysis of Refinitiv data
There were 247 publicly announced M&A transactions in the U.S. this year, one for nearly every trading day, representing an aggregate value of over $1 trillion.
In terms of completed or interrupted transactions, 166 deals closed in 2021, while 9 mergers were terminated and 8 overbids occurred in which an interloper offered a higher consideration for the target.
This annual tally indicates a 95.1% deal completion rate, including a 4.4% overbid rate and a 4.9% failure rate. Over the past decade, 6% of M&A transactions have been terminated, making 2021’s 4.9% termination rate better than average in terms of the success of merger arbitrage investments.
The higher success rate of merger arbitrage investments, due to a lower termination rate, combined with higher yields offered within the asset class, has translated into a bounty for merger arbitrage returns this year.
As merger arbitrage continues to perform well, the asset class steadily grows. Merger arbitrage is now a $90 billion asset class, up 302% from a decade ago.
Despite having the reputation as perhaps the most consistent-performing hedge fund strategy, merger arbitrage is still woefully under-allocated to in most investor portfolios.
Nevertheless, given the attractive historical risk-reward metrics of merger arbitrage, along with its bright outlook, we expect the asset class to continue to grow. As they say, the “numbers don’t lie” and flows follow performance.
Our outlook for 2022 remains bullish. We foresee the record pace of M&A announcements continuing and expect the aggregate deal value to meet or exceed 2021 levels. The major risk potentially hindering this forecast would be a rapid rise in interest rates and an accompanying equity bear market.
We continue to forecast above-average returns for merger arbitrage, given the higher success rate combined with wider spreads and higher yields offered.
The average U.S. merger arbitrage opportunity yields 8.0%, double that of junk bonds.
Pre-Covid, merger arb and junk bonds yielded an equivalent amount. Since then, junk bond yields have fallen 100bps while merger arb yields have risen 300bps.
Given the wide spreads within arbitrage, combined with the lower than historical deal termination rate, we expect higher than average merger arbitrage returns for 2022. We forecast a high-single digit annual return for merger arbitrage, compared to the 4.3% average since 2011, because current yields are 8.0%. Compared to the yields offered in fixed income, we believe that yield-focused investors could perhaps do better by allocating a portion of their fixed income mandates to merger arbitrage.
The AlphaRank Merger Monitor below represents Accelerate’s proprietary analytics database on all announced liquid U.S. mergers. The AlphaRank Merger Arbitrage Effective Yield represents the average annualized return of all outstanding merger arbitrage spreads and is typically viewed as an alternative to fixed income yield.
Each individual merger is assigned a risk rating:
- AA – a merger arbitrage rated ‘AA’ has the highest rating assigned by AlphaRank. The merger has the highest probability of closing.
- A – a merger arbitrage rated ‘A’ differs from the highest-rated mergers only by a small degree. The merger has a very high probability of closing.
- BBB – a merger arbitrage rated ‘BBB’ is of investment grade and has a high probability of closing.
- BB – a merger arbitrage rated ‘BB’ is somewhat speculative in nature and has a greater than 90% probability of closing.
- B – a merger arbitrage rated ‘B’ is speculative in nature and has a greater than 85% probability of closing.
- CCC – a merger arbitrage rated ‘CCC’ is very speculative in nature. The merger is subject to certain conditions that may not be satisfied.
- NR – a merger rated NR is trading either at a premium to the implied consideration or a discount to the unaffected price.
The AlphaRank merger analytics database is utilized in running the Accelerate Arbitrage Fund (TSX: ARB), which may have positions in some of the securities mentioned.
* AlphaRank is exclusively produced by Accelerate Financial Technologies Inc. (“Accelerate”). Visit AccelerateShares.com for more information. Disclaimer: This research does not constitute investment, legal or tax advice. Data provided in this research should not be viewed as a recommendation or solicitation of an offer to buy or sell any securities or investment strategies. The information in this research is based on current market conditions and may fluctuate and change in the future. No representation or warranty, expressed or implied, is made on behalf of Accelerate as to the accuracy or completeness of the information contained herein. Accelerate does not accept any liability for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on all or any part of this research and any liability is expressly disclaimed. Accelerate may have positions in securities mentioned. Past performance is not indicative of future results.