Higher interest rates lead to more attractive arbitrage yields.
Maxam Arbitrage Fund – Q2 2023 Commentary
The Maxam Arbitrage Fund1 gained +1.1%in the second quarter and is up +2.7% through the first six months of 2023. The S&P Merger Arbitrage Total Return Index gained +0.3% in Q2 and is down -1.2% year to date.
Positive fund performance in the quarter was buoyed by the successful completion of 12 M&A deals and our SPAC holdings benefiting from liquidations, extensions, and the ongoing growth of cash held in-trust due to higher interest rates.
Ebb and flow.
The arbitrage opportunity set continues to be heavily influenced by today’s higher interest rates and the ongoing and increased scrutiny that the FTC under the Biden administration, and certain other foreign regulators, are applying to select transactions – most notably to larger capitalization deals.
In the second quarter we saw the UK’s Competition and Markets Authority (CMA) move to block the Activision/Microsoft deal, the termination of the First Horizon/TD Bank deal after the parties failed to obtain regulatory approval, Canaccord’s failed management buyout, and the FTC seeking to block Amgen’s acquisition of Horizon Therapeutics with a novel and untested theory of harm.
Higher interest rates and a challenging regulatory environment have almost certainly led to a slowdown in large cap transactions in recent months. As we highlighted in our Q1 commentary, we continue to see a barbell of return opportunity and risk across two broad groups of deals. Large and mega-cap transactions typically face higher regulatory and duration risk, whereas small and mid-capitalization deals usually do not face the same regulatory risk, plus they close more quickly and often trade at higher gross spreads.
With risk management core to our process, we continue to deploy capital into an attractive opportunity set across the market capitalization spectrum and characterized by deals with arbitrage yields in the high single digit to low double-digit range.
The fund invested in seven new deals during the quarter, had 12 successful deal closures and experienced one deal break (a small position in First Horizon). Owned deals that successfully closed during the quarter included: Shaw Communications, Provention Bio, Yamana Gold, Magnet Forensics, Oak Street Health, Maxar Technologies, TravelCenters of America, E Automotive, Qualtrics International, Indus Realty Trust and Bellus Health.
At the end of the second quarter the fund held 24 merger arbitrage positions.
Gather up your jackets, move it to the exits2.
The SPAC universe continues to be largely in a state of run-off. At the end of the second quarter there were 391 listed SPACs down from over 530 at the end of 2022 – most of the decrease came from liquidations rather than closed deals; and the pace of new SPAC IPOs continued to slow with only six during the quarter3.
We continue to take advantage of SPAC liquidations and extensions with our systematic and quantitative process – recall that SPAC sponsors are faced with either liquidating at maturity and returning capital to investors or offering incentives to shareholders to encourage them to stay invested for another few months, such as topping up trust accounts.
In addition to liquidations and extensions, we have also identified several unique opportunities where we believe we have exposure to some interesting upside optionality.
SPACs continue to present us with the prospect of earning annualized returns in the mid-to-high single digit range on securities that are backed by T-bills held in trust. This risk/reward strikes us as quite attractive, especially when you consider that these returns are largely taxed as capital gains.
As of June 30 the fund was well-diversified across 51 SPACs.
Every new beginning comes from some other beginning’s end4.
When one deal closes, we receive and redeploy the proceeds into another deal to further compound that capital – a key and attractive characteristic of the strategy. Thus, new M&A activity is important.
We are mindful of the impact that an environment of higher interest rates and tighter credit conditions can have on deal flow. As a result, we may see fewer large and mega cap transactions, especially given the more hostile regulatory environment towards such deals.
Despite the natural ebb and flow of capital markets activity – through bull markets, bear markets, recessions, and geopolitical events – the quantum of overall deal activity through various cycles has historically enabled arbitrageurs to construct a well-diversified portfolio.
Constructively, and as mentioned earlier, we foresee an increasing opportunity in small and mid-cap deals where regulatory risks are much lower. These deals also tend to close more quickly than their larger cap brethren and often trade at more attractive arbitrage yields due to larger pools of capital not being able to allocate efficiently to them.
With many quality small-caps trading at steep discounts to their larger peers, plus numerous busted IPOs and de-SPACs getting no love from investors, opportunistic acquirers are increasingly likely to step-up. We will continue to allocate actively and selectively to this attractive segment of the arbitrage opportunity set.
Merger arbitrage spreads are attractive right now – both on an absolute and relative basis – presenting investors with an opportunity to earn returns from a strategy that exhibits low correlation with traditional equities and bonds.
Higher interest rates have historically been a positive factor for arbitrage returns because arbitrage spreads in essence reflect the prevailing risk-free rate plus deal risk premia. And the low duration nature of the strategy helps us quickly take advantage of those attractive spreads as deals complete.
We continue to navigate and deploy capital into an attractive opportunity set with our quantitative, data-centric and risk management focused investment process.
Thank you for your trust and confidence. Please don’t hesitate to reach out with any questions.
Travis Dowle, CFA
President & Fund Manager
Maxam Capital Management Ltd.
1 Maxam Arbitrage Fund, Class F, net of fees and expenses. Inception date October 1, 2020. Please contact us regarding other series of fund units or visit our website www.maxamcm.com
2 Lyrics from ‘Closing Time’ by Semisonic – nominated for the best rock song Grammy in 1999. https://en.wikipedia.org/wiki/Closing_Time_(Semisonic_song)
3 SPAC stats from www.spacresearch.com
4 Another great lyric from ‘Closing Time’ (see footnote 2 above). For us this lyric signifies part of the attractiveness of an arbitrage strategy – when a deal closes, we receive the proceeds and invest them into another new deal to further compound that capital. And on it goes!
Maxam Capital Management Ltd. is the manager for the Maxam Arbitrage Fund. Important information about the Fund is contained in the Fund’s Simplified Prospectus, which should be read before investing. This presentation is neither an offer to sell securities nor a solicitation to sell securities. Disclosed historical returns for periods greater than one year are annualized unless otherwise noted and are net of fees and expenses. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the Simplified Prospectus before investing. Any indicated rates of return are the historical annual total returns including changes in value and reinvestment of all distributions and does not take into account sales, redemption, distribution or optional charges or income taxes payable by any unitholder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated. This document is not intended to provide legal, accounting, tax, or investment advice. Please consult an investment advisor and read the prospectus for the Maxam Arbitrage Fund prior to investing. Please contact us for more information at: (604) 685-0201 firstname.lastname@example.org www.maxamcm.com