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  • Writer's pictureRobert von Hoffmann

VH Standard Merger Arb Fund - Monthly Letter (October '23)

Updated: Feb 2

VH Standard AM - Monthly Letter (9-23)
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VH Standard Asset Management

This month, we’re going to scale back the letter a bit. We continue to have enthusiasm for merger arbitrage as an investment strategy, but some of the attractiveness that we wrote about in our first letter has rightfully diminished. Most notably, a key metric that we closely monitor has changed significantly since mid-August, with the implied probability of completion tightening from ~80% up to ~85% across the M&A universe, as of September 30. This current level is more closely aligned with the implied probabilities we saw between May 2020 (after covid) and May 2022, a period which ended with the appointment of Alvaro Bedoya as an FTC commissioner and the beginning of a Lina Khan run FTC with Democratic majority.

Fortunately, this recent adjustment since mid-August has benefitted our investments as spreads tightened and the market perception of companies’ ability to close deals strengthened. A few key moments can be seen as potentially the catalysts for this change, with the Activision-Microsoft court case win against the FTC, the Horizon Therapeutics settlement, and the completion of the Black Knight-ICE acquisition, among others.

We saw this impact firsthand in another statistic that we closely monitor – deals with 10%+ absolute spreads as a percentage of our total deals. At the end of July, 23% of the deals we were invested in had an absolute spread of greater than 10%. This number is now down to 12.5%, as deals have closed, and several outstanding transactions have crossed the threshold to below a 10% absolute spread. The reason we look at this stat is because the absolute spread can tell you a piece of the story and give you another detail in assessing the market’s uncertainty around timing and transaction risk. The higher percentage of your portfolio in deals with 10%+ absolute spreads, the more uncertain the market is around M&A arbitrage. It’s not an exact theory, but it’s a detail to us.

One thing we spoke about in our first letter was that the regulators were taking a tougher stance on deals, but that the laws have not changed substantially. We felt at the time that this discrepancy between the regulator’s stance and the reality of what can be done was an opportunity to capture additional value. This opportunity has since closed somewhat as the market’s perception of risk has moved closer to the “reality” and away from their fear of regulators. This would usually lead us to increase our skepticism; however, we’re not afraid of a realistic viewpoint, we’re skeptical of a nothing-can-go-wrong viewpoint in risk arbitrage.

As this shift in perception has happened, we’ve seen the opportunity set become a little less attractive for new investments, but many deals in the M&A universe still exceed our hurdle rate for investment (or as we like to say, for “insuring”). So, we continue to recycle capital from the completed deals into new opportunities.

More specifically, there’s two stats that we find particularly attractive on a value-add basis in the M&A space: the historical implied probability of closing and the historical spreads. Historically, the implied probability of completion tends to be above 90%, which is where it was leading up to Covid. And this makes sense since historically about 95%-96% of all deals close. This gives us optimism that although arbs are more confident in deals closing, they still have a bit of skepticism and caution. It’s not outright fear, but it’s also not the “good times” yet.

Secondly, as we’ve talked about before, spreads of M&A transactions need to compensate the investor for the risk of the transaction breaking and the expertise & time that it takes to become a knowledgeable merger arbitrageur. The second part is icing on the cake to someone with expertise. There’s an advantageous aspect of arbitrage that a fund can only get so big before the opportunity set becomes so limited that your risk increases substantially – Berkshire Hathaway had this problem, which is why they don’t invest in merger arb the same way they used to.

The other part, compensation for risk, means that all deals with less than 100% probability of closing need to provide the investor with a worthwhile alternative to holding cash & treasuries. As interest rates have risen, we’ve seen this play out and hold true, as new deals have been announced with new spreads positively correlated to rising rates. At the end of September in 2019, the average yield for all M&A transactions was about 4% annualized.1 Five years later at the end of September in 2023, the average yield is about 11.1% annualized,1 which is a hell of a lot higher than 4%. It’s also still a lot more attractive on a value-add basis, as we see the risk being priced in assuming a ~5.8% spread over the risk-free 3-month US T-bill that was yielding 5.32% at the end of September. As a firm, we aim to produce absolute returns between 3%-5% over the risk-free rate, so we still think merger arb is attractive at these levels – even after the spread tightening we’ve seen in recent months. 


We had a gross return of +1.14% for September, which brings our gross return to +4.26% year-to-date. Net returns for the month were +1.06%, bringing our net return to 4.03%, with a 1% management fee structure. During the month of September, we saw a profit from our AVGO short position which is our hedge from the VMW-AVGO transaction. We realized our gains on half of this short position at an average price per share of $779.89, as headlines broke that Apple was considering changing their relationship with AVGO in 2025. The rest of the gains were substantially made up of the completion of the CELL transaction, as well as continued progress in the ATVI, SGEN, & HZNP transactions, among several other smaller gains.

Thank you for reading. We look forward to continuing to build this portfolio. If you’d like to have a conversation, feel free to reach out.

“Great things are done by a series of small things brought together.” – Van Gogh

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