Return-hungry investors flock to M&A hedge funds

Four thousand U.S. dollars are counted out by a banker counting currency at a bank in Westminster, Colorado in this November 2009 file photo.

LONDON (Reuters) - Investors are flocking to hedge funds that bet on mergers and acquisitions (M&A) in the hope that a revival in takeover activity will help deliver more of the bumper returns they enjoyed in last year's rally.

Prime brokers -- who offer services to hedge funds -- say such event-driven funds, which bet on announced takeovers as well as restructuring or even bankruptcies, top investor wish lists and more are set to be launched.

Event-driven funds, which made 20.4 percent last year according to the Credit Suisse/Tremont hedge fund index, adopt strategies such as buying shares in a target company or betting on lower prices for the acquirer.

London-based Tyrus Capital has raised more than $800 million for an event-driven fund, Senrigan Capital set up an Asian event-driven fund and Black's Link Capital is also launching a similar fund, according to media reports.

"There's a lot of investor interest. A lot of money is being thrown at that," said one prime broker, who declined to be named. "Nine months ago it was the thing people were least interested in, and now it's top of the list."

According to a survey by TrimTabs/BarclayHedge, so-called event-driven funds saw $3.1 billion of net inflows in January, the second most popular strategy, behind funds that invest in distressed debt issued by high-risk companies.

RECOVERY EXPECTED

While M&A activity is still nowhere near pre-credit crisis levels, investor appetite has been reignited by Kraft's $18.4 billion takeover of Cadbury, cheap equity valuations and reduced competition from banks' proprietary trading desks.

However, hopes for a rapid recovery in M&A have so far proved unfounded this year, particularly in Europe.

Global announced M&A is up just 4 percent versus the same time last year, at $469 billion, and Europe's share of targeted companies has halved to 16 percent, Thomson Reuters data shows.

And with some exceptions, such as Babcock's tilt at fellow British support-services company VT Group, there has been a dearth of deals involving two listed companies, which are the easiest for hedge funds to trade.

However, funds hope that rising boardroom confidence, higher corporate cash balances and currency shifts that make costly targets more attractive will kick-start deals.

"We expect M&A to be a constant theme throughout the year, with weak sterling a benefit for valuations from an overseas perspective," said Philip Hardy and Nick Shenton, managers of Polar Capital's UK Absolute Return fund.

They also cite cheap equity valuations. The FTSE 100 is on a price/earnings ratio of 11.6 times -- a level described by Toscafund chief executive Martin Hughes as so low it was "absurd".

"M&A will be better this year than last year, although we are not as bullish about the outlook as we were last quarter," said a senior London-based M&A banker.

"We have a view, as do others, that M&A in Europe is likely to come back this year," said Eddie Guillemette, managing director in Bank of AmericaMerrill Lynch's prime brokerage.

"TEMPTING"

Hedge fund investors have also been encouraged by the deep cuts investment banks have made to proprietary trading desks where they make market bets with their own money, taking a fierce competitor out of the equation.

"Some banks committed huge amounts of capital to event-driven (strategies), but now the missing player at the party is prop desks," said Mark Harrison, European head of prime finance at Citigroup.

Hedge funds made bumper gains of 20.12 percent last year, according to Hedge Fund Research, largely on the back of fast-rising equity markets. The FTSE 100, for instance, soared 57 percent from trough to peak last year.

Few expect life to be so easy this year, but managers hope that their bets on M&A -- which are less dependent on rising markets -- can help plug the gap.

Edgar Senior, Credit Suisse's head of capital services in London said "In event-driven, you have a portfolio of positions in typically more specific events ... It's quite tempting to look at a strategy that relies on little opportunities that can add up to 10-15 percent."

(Additional reporting by Quentin Webb and Victoria Howley)

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