Above the Fray

A Misunderstood and Underappreciated Investment Technique

Over the years, event driven investing (or “arbitrage” as it is also called) has been an important component of our investment activity with the capital that has been entrusted to our care. I find it interesting and somewhat bewildering that I get more questions about this activity than I do about our long-term investments which continue to be the mainstay of what we do at Stacey Muirhead. For some reason, event driven investing seems shrouded in mystery and holds a special allure for our investors (if anything about investing can be described as alluring!)

While the use of this investment technique is not widespread, we did not invent it and we are certainly not the only firm that engages in event driven investing. The intellectual founder of value investing, Benjamin Graham, engaged in this activity with his investment partnership back in the 1930’s and 40’s. Warren Buffett has also been active in this field throughout his career. Even though Berkshire Hathaway’s large scale has caused its involvement with event driven investing to dwindle over the last decade, Berkshire did participate in the recent merger between Monsanto and Bayer. While our involvement ebbs and flows based on the available opportunities, we have had an exposure as high as 45% of our Partnership net assets in event driven investments as well as periods of time where we have had no exposure at all.

Let me review some of the basics with you. Event driven investing is the pursuit of profits from announced corporate events. Events such as mergers, takeovers, spin offs, recapitalizations, liquidations and tender offers can all lead to an investment opportunity. To evaluate a potential event driven investment, you need to answer four questions: (1) What is the probability of the promised event occurring? (2) How long will your money be tied up? (3) What is the likelihood of something better happening? (4) What will happen if the promised event does not occur? The main example of something better happening would be a competing takeover bid at a higher price. Anti-trust and other regulatory issues, lack of shareholder approval and financing glitches are the most common reasons why an event does not occur. When a transaction breaks, it can be painful, so event driven investors need to have a good batting average to achieve decent investment results.

We like event driven investing for several reasons. Most importantly, we expect to profit regardless of the behaviour of the stock market in most circumstances. As such, holding event driven investments in our two funds tends to deliver more consistent returns from year to year than our long-term investments do. This tends to result in better overall returns (at least relatively) in years of market decline. Conversely, it can act as a drag on performance when markets are strong. We think of event driven investing as another page in our investment “playbook” and believe that is especially important in helping us to be disciplined in our long-term investment activity. Because we have other things we can do, behaviorally we are not tempted to lower our investment standards for our long-term investment commitments. While event driven investing is not complicated, it is also not easy. It mostly requires a lot of time and effort to wade through the voluminous documents filed with the various regulators in connection with the specific event. This is an important consideration. While unexpected developments can reach up and scuttle any transaction, if you develop a basic understanding of the process and make the effort to read the documents, you too can be a successful event driven investor (or perhaps you prefer the more elegant sounding title “arbitrageur”!)

I recently gave a presentation on event driven investing at The CAVIE (Center for the Advancement of Value Investing Education) Annual Investment Seminar. CAVIE is associated with the Ben Graham Centre for Value Investing at the Ivey Business School. Dr. George Athanassakos, the chair of the Ben Graham Centre, has done a wonderful job teaching and proselytizing value investing around the world. Attendees at the week-long CAVIE event came from Canada, the United States, Columbia, China, Singapore, Australia, Poland, and the United Kingdom (I am sure I have missed a few countries!) It was a wonderful experience for me and I enjoyed the energy I received from a room of people who paid their own money to attend this seminar (during a very hot July in Toronto!) because they wanted to improve their investing skills. The PowerPoint presentation and video can be found on the Ben Graham Centre for Value Investing website. You can watch the video on You Tube by clicking on the following link: https://www.youtube.com/watch?v=qG1QLg25_VM&feature=youtu.be. We will try to post a link on our website as well.

 

“Above the Fray” is a regular blog written by Jeffrey Stacey, Chairman and CEO of Stacey Muirhead Capital Management Ltd., which discusses items of interest related to investing, finance and business. This is not a solicitation.

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