What Is It?
Event driven managers seek to profit from security pricing
inefficiencies that may occur when companies are involved
in corporate events such as mergers, takeovers, restructures
(including share buy-backs, spin-offs and capital returns)
and capital raisings.
The investment focus of such a manager is directed to analysing
the likely effect on security prices due to a corporate event,
rather than analysing and researching company earnings or
dividend streams, which is the focus of traditional equity
Due to the types of investments made by such managers and
the general short to medium term holding period of each investment,
the returns of event driven investments are likely to be less
sensitive to movements in the general equity market than conventional
The aim is to produce consistent high risk-adjusted returns
that are non-market correlated.
Types of Strategies
There are numerous investment strategies that may be used
to profit from different corporate events. The timing and
implementation of each strategy is a matter of manager judgement.
Merger or risk arbitrage is the most well known event driven
strategy and involves the acquisition of securities that are
subject to a takeover or merger at a discount to the takeover
or merger price, or where a higher price is expected. If a
takeover offer contains a security (or non cash) element,
the event driven manager may short sell the securities offered
as consideration or use derivatives to reduce the exposure
to downward movements in the bidding company's security price.
Some less well known arbitrage activities that an event driven
manager may implement include dividend and rights trading
arbitrage strategies. For example, a company may raise new
equity capital that is not entitled to an upcoming dividend.
The event driven manager may be able to simultaneously buy
the newly issued securities and short sell the existing securities
at a price differential that exceeds the potential dividend
and stock borrow costs.
If the newly issued capital is raised by way of a renounceable
rights issue, the event driven manager may be able to simultaneously
buy the rights and short sell the existing securities at a
price differential that exceeds the amount required to subscribe
for the newly issued shares and stock borrow costs. In both
cases, low risk arbitrage profits may be generated that are
independent of the direction of the security price and equity
Changes to the composition of stock indices and location
of a security's primary exchange listing may also enable an
event driven manager to profit from price movements that result
from changes in shareholder bases.
The event driven manager will also assess other corporate
events and arbitrage opportunities and take either long or
short positions depending on the manager's view as to the
risk/reward trade-off of the specific investment.
The Efficiency Conundrum
Although markets are generally efficient, certain securities
at various times may be priced inefficiently from the perspective
of an event driven manager. However, too many event driven
managers operating in a small or illiquid market will tend
to remove such inefficiencies fairly quickly and therefore
reduce the risk-adjusted returns.
In such cases, running with the herd (ie putting on the same
trades as other event driven managers) can be a recipe for
mediocre risk-adjusted returns. Therefore, certain event driven
managers may implement trades that are the opposite of the
trades executed by the majority of event driven managers.
In summary, market efficiency may be welcomed by economists,
but not by event driven managers - at least until the trade
has been fully executed.
As with all investment strategies, successful implementation
requires judgement. A skilful event driven manager should
be able to analyse events and judge the relevant risk/reward
characteristics of each potential trade. He or she must decide
in which events to invest and, more importantly, he or she
must decide in which events NOT to invest, as a losing trade
may require multiple winning trades just to replenish the
In addition, a successful manager must constantly assess
and control risk - knowing what size investments to make,
when to take profits and when to cut losing trades.
Event driven investing requires corporate activity and some
level of inefficiency. There are few riskless trades - but
the successful management of assessed risks should, over time,
deliver superior returns for the event driven investment strategy.