النص 🔗
1
00:00:01,360 --> 00:00:02,159
Hey, everyone.
2
00:00:02,159 --> 00:00:03,359
Corey Hofstein here.
3
00:00:03,359 --> 00:00:07,279
I wanna personally invite you to an event
that's all about rethinking portfolio
4
00:00:07,279 --> 00:00:08,080
construction.
5
00:00:08,160 --> 00:00:13,199
On October 8, we're hosting the return stacking
symposium at Cboe Global Markets in Chicago.
6
00:00:13,684 --> 00:00:18,964
It's a one day in person deep dive into capital
efficient strategies, and we're featuring
7
00:00:18,964 --> 00:00:24,644
speakers like Jonathan Glidden, CIO of Delta
Airlines, Patrick Casley from One River, and
8
00:00:24,644 --> 00:00:28,724
Mark Horbul, managing director of the
Systematic Strategies Group at Canada Pension
9
00:00:28,724 --> 00:00:28,964
Plan.
10
00:00:29,370 --> 00:00:33,929
This is your chance to hear directly from the
institutional allocators leading the charge on
11
00:00:33,929 --> 00:00:35,929
portable alpha and return stacking.
12
00:00:36,170 --> 00:00:41,609
But space is limited, so head over to
returnstacked.com/symposium to learn more and
13
00:00:41,609 --> 00:00:42,409
register.
14
00:00:42,409 --> 00:00:43,289
Hope to see you there.
15
00:00:47,564 --> 00:00:52,204
Hello, and welcome to the Get Stacked
Investment Podcast, where we delve into the
16
00:00:52,204 --> 00:00:54,364
exciting new world of return stacking.
17
00:00:54,524 --> 00:00:59,909
Join us as we break down complex financial
concepts into accessible insights, speak with
18
00:00:59,909 --> 00:01:04,709
leading experts in the space, and analyze real
world applications for return stacking.
19
00:01:05,109 --> 00:01:10,229
GetStacked is here to help you break out of the
traditional portfolio construction mold and get
20
00:01:10,229 --> 00:01:13,875
you to start thinking differently about the
path investment.
21
00:01:14,194 --> 00:01:19,075
Corey Hofstein is the co founder and chief
investment officer of Newfound Research, and
22
00:01:19,075 --> 00:01:24,674
Rodrigo Gordillo is the president and portfolio
manager of Resolve Asset Management Global.
23
00:01:25,250 --> 00:01:30,209
Due to industry regulations, we will not
discuss any funds managed or sub advised by
24
00:01:30,209 --> 00:01:31,890
these firms on the podcast.
25
00:01:32,530 --> 00:01:38,094
All opinions expressed by podcast participants
are solely their own opinion and do not reflect
26
00:01:38,094 --> 00:01:42,655
the opinion of neither Newfound Research or
Resolve Asset Management Global.
27
00:01:42,894 --> 00:01:48,254
This podcast is for informational purposes only
and should not be relied upon as a basis for
28
00:01:48,254 --> 00:01:49,454
investment decisions.
29
00:01:49,854 --> 00:01:54,950
Clients of these firms may maintain positions
and securities discussed in this podcast.
30
00:01:55,430 --> 00:01:58,469
For more information, visit returnstack.com.
31
00:02:14,495 --> 00:02:19,775
When a company, when there's an announcement
that one company is going to buy another, if
32
00:02:19,775 --> 00:02:23,775
this is a public company that's trading, the
company that's getting acquired, typically its
33
00:02:23,775 --> 00:02:30,750
share price is going to jump up towards the
announced price, but it typically doesn't go
34
00:02:30,750 --> 00:02:31,710
all the way.
35
00:02:32,430 --> 00:02:36,990
There's usually a spread left and that spread
is going to represent two things.
36
00:02:36,990 --> 00:02:39,389
One, it's going to represent the time value of
money.
37
00:02:39,844 --> 00:02:42,724
The deals typically aren't closing imminently.
38
00:02:42,805 --> 00:02:48,405
They're typically closing say an expected deal
time might be six to twelve months, and so the
39
00:02:48,405 --> 00:02:52,645
market's going to build in some sort of time
value of money for that deal to close.
40
00:02:53,050 --> 00:02:59,129
The other thing the market is going to price in
is the expected expectation of any deal break.
41
00:02:59,449 --> 00:03:04,090
We have very strong laws about mergers and
acquisitions in The US, but there's still a
42
00:03:04,090 --> 00:03:08,555
probability that a deal might fall apart for
capital reasons or deal might fall apart
43
00:03:08,555 --> 00:03:10,634
because of regulatory reasons.
44
00:03:10,715 --> 00:03:15,834
And so that represents deal break risk and
that's going to be baked into the premium as
45
00:03:15,834 --> 00:03:16,074
well.
46
00:03:16,074 --> 00:03:21,669
And so you can almost think of how far the deal
jumps, how far the stock price jumps from where
47
00:03:21,669 --> 00:03:27,269
it was trading to the announced deal prices, a
pseudo probability of how much the market
48
00:03:27,269 --> 00:03:32,469
thinks the deal is likely to get done with some
time value money baked in there.
49
00:03:32,709 --> 00:03:39,584
And so what merger arbitrage does is it says
after the deal has been announced, we are going
50
00:03:39,584 --> 00:03:41,665
to buy into that acquired company.
51
00:03:42,064 --> 00:03:46,145
If it's an all cash deal, if it's a cash plus
stock deal, we're going to buy into that
52
00:03:46,145 --> 00:03:52,500
company and short the stock of the acquirer, if
it's a public company, and then we're going to
53
00:03:52,500 --> 00:03:56,099
try to capture that remaining spread over time.
54
00:03:56,340 --> 00:03:59,540
It's less an arbitrage in the sense of a true
arbitrage.
55
00:03:59,540 --> 00:04:01,699
I like to think of it as a risk premium, right?
56
00:04:01,699 --> 00:04:05,594
A lot of those investors who are along for the
ride got that initial jump.
57
00:04:05,754 --> 00:04:11,114
There's a little bit of juice left to squeeze
in that spread and so when you're stepping in
58
00:04:11,114 --> 00:04:16,314
at that price that you are taking on the risk
that the deal could fall apart, you're taking
59
00:04:16,314 --> 00:04:21,639
on the risk that the deal might take longer
than the market's expecting And so by taking on
60
00:04:21,639 --> 00:04:24,279
those
Load full transcript
risks, you should earn a risk premium.
61
00:04:24,279 --> 00:04:30,839
So a well diversified M and A portfolio in the
public markets, once these deals are announced,
62
00:04:31,399 --> 00:04:37,904
should look very much like a mix between a
duration, a low duration portfolio, you're
63
00:04:37,904 --> 00:04:42,625
getting paid compensated for that time value
money premium and a little bit of something
64
00:04:42,625 --> 00:04:44,785
that looks a little bit like credit risk.
65
00:04:44,785 --> 00:04:49,729
It's not perfectly credit risk, but it's credit
risk adjacent and it's a different unique risk
66
00:04:49,729 --> 00:04:51,169
premium that you can earn.
67
00:04:54,769 --> 00:04:56,370
There's two ways I'd want to answer this.
68
00:04:56,370 --> 00:04:59,250
One is an evergreen answer, right?
69
00:04:59,250 --> 00:05:03,169
When we're building portfolios, I think it's
always prudent to be looking to diversify
70
00:05:03,464 --> 00:05:07,305
across as many unique risk premia as possible.
71
00:05:07,305 --> 00:05:14,504
When we look at the returns of a merger ARB
strategy, it's lowly correlated to bonds.
72
00:05:14,745 --> 00:05:19,079
It's got about a correlation point five to
equities, a correlation of about point five to
73
00:05:19,079 --> 00:05:20,519
the credit risk premium.
74
00:05:20,519 --> 00:05:25,479
And so as we're looking to just further
diversify our portfolios structurally, I think
75
00:05:25,479 --> 00:05:28,040
it's a great evergreen allocation.
76
00:05:28,680 --> 00:05:34,105
At this point in time, we're in an environment
where credit spreads are very thin.
77
00:05:34,185 --> 00:05:40,904
And so for more conservative investors who have
a lot of investment grade corporate bond
78
00:05:40,904 --> 00:05:47,465
exposure or even high yield bond exposure, the
question you have to ask is, we being fairly
79
00:05:46,669 --> 00:05:49,310
compensated for the risk we're taking?
80
00:05:49,629 --> 00:05:53,949
Particularly if there is a potential hard
landing coming around the corner from an
81
00:05:53,949 --> 00:05:55,069
economic perspective.
82
00:05:55,389 --> 00:05:59,709
I'm not going to prognosticate on that, but
when you have credit spreads this thin, the
83
00:05:59,709 --> 00:06:01,985
margin for error is quite low.
84
00:06:01,985 --> 00:06:05,264
And so one of the things we're talking a lot
about is saying, what if you took the merger
85
00:06:05,264 --> 00:06:09,585
risk premium and put it on top of treasuries?
86
00:06:10,145 --> 00:06:15,850
And what you end up with is something that over
the long run looks a lot like a corporate bond
87
00:06:15,850 --> 00:06:20,410
return profile, but the excess return that
you're earning above the treasuries isn't
88
00:06:20,410 --> 00:06:24,009
coming from credit risk, it's coming from deal
break risk.
89
00:06:24,330 --> 00:06:26,730
And again, there's some low correlation there.
90
00:06:26,730 --> 00:06:30,835
There is some similarities in certain markets,
but it
is its own unique risk premium.
91
00:06:30,835 --> 00:06:35,795
And so we think it makes a great diversifier to
corporate bonds in an environment like we're in
92
00:06:35,795 --> 00:06:36,355
today.
93
00:06:40,115 --> 00:06:44,355
The expectation is typically there is a bit of
cyclicality to merger arbitrage.
94
00:06:44,355 --> 00:06:44,595
Right?
95
00:06:44,595 --> 00:06:47,689
People typically think, oh, there's a big
recession, right?
96
00:06:47,689 --> 00:06:48,970
That's bad for M and A.
97
00:06:48,970 --> 00:06:52,490
That is true to a certain extent and that's
where you do tend to see a little bit of
98
00:06:52,490 --> 00:06:56,730
correlation between merger arbitrage and credit
and equities.
99
00:06:56,810 --> 00:07:01,884
M and A deals might dry up, They might take
longer for people to get the financing, but we
100
00:07:01,884 --> 00:07:05,805
have very strong M and A laws in this country.
101
00:07:05,805 --> 00:07:10,365
The example I always give is Elon Musk buying
Twitter, now X.
102
00:07:10,605 --> 00:07:11,004
Right?
103
00:07:11,004 --> 00:07:17,759
He made a proposal in a somewhat joking manner
and then Delaware law forced him to buy
104
00:07:17,759 --> 00:07:18,399
Twitter.
105
00:07:18,399 --> 00:07:18,639
Right?
106
00:07:18,639 --> 00:07:22,240
So it's very hard to get out of these deals
once they're announced.
107
00:07:22,639 --> 00:07:27,519
And so when you look at a diversified merger
arbitrage portfolio, you're talking about a
108
00:07:27,519 --> 00:07:34,064
diversified set of idiosyncratic risks versus
when you look at credit, you tend to be looking
109
00:07:34,064 --> 00:07:39,504
at something that is far more cyclical and
tends to have a lot more correlation to equity
110
00:07:39,504 --> 00:07:43,264
markets because it's a pseudo proxy for what's
happening in the economy.
111
00:07:43,264 --> 00:07:47,990
And so it's not to say there isn't some sort of
economic similarity to them.
112
00:07:47,990 --> 00:07:52,709
Again, that correlation is about a point five,
but it's not perfect and you tend to find that
113
00:07:53,029 --> 00:07:58,949
M and A strategies, merger arbitrage strategies
have far less downside correlation to equities
114
00:07:59,074 --> 00:08:00,355
than credit does.
115
00:08:04,194 --> 00:08:09,954
I think what you find with a traditional merger
arb strategy, if you're just buying an off the
116
00:08:09,954 --> 00:08:14,800
shelf merger arb strategy, this is typically
like a short duration bond fund.
117
00:08:15,439 --> 00:08:22,319
The way we're putting together our bonds and
merger arbitrage strategy is it's going to be
118
00:08:22,319 --> 00:08:25,375
something much more an intermediate term fund.
119
00:08:25,375 --> 00:08:28,095
You're just generic investment grade credit
strategy.
120
00:08:28,415 --> 00:08:35,215
We are taking a diversified portfolio of
treasury exposure from two year, five year, ten
121
00:08:35,215 --> 00:08:42,399
year out to US long bond treasury exposure and
then stacking on top of that the merger
122
00:08:42,399 --> 00:08:44,399
arbitrage risk premium.
123
00:08:44,399 --> 00:08:46,240
That's our ambition at least.
124
00:08:46,240 --> 00:08:50,799
And so when you put those two things together,
you get something that looks a lot more like
125
00:08:50,799 --> 00:08:52,319
investment grade corporate bonds.
126
00:08:52,319 --> 00:08:57,384
And so that's where we would recommend people
fund this allocation from it.
127
00:08:57,384 --> 00:09:02,985
They should sell some of their core investment
grade corporate bonds, buy some of a portfolio
128
00:09:02,985 --> 00:09:08,000
like this, the bonds plus merger arbitrage
strategy, And in doing so, we think over the
129
00:09:08,000 --> 00:09:10,959
long run, you get a very similar return
profile.
130
00:09:10,959 --> 00:09:15,440
I actually think merger arbitrage has
historically been more attractive than the
131
00:09:15,440 --> 00:09:16,639
credit risk premium.
132
00:09:16,720 --> 00:09:18,159
But let's say it's the same.
133
00:09:19,115 --> 00:09:22,554
The benefit there really is then the
diversification, right?
134
00:09:22,554 --> 00:09:27,274
That you're just adding yet another risk
premium to your portfolio and helping spread
135
00:09:27,274 --> 00:09:31,514
your bets into unique places that you should
get paid for allocating your money.
136
00:09:35,929 --> 00:09:41,049
When we think about beating the market, there's
very few ways in which you can actually do
137
00:09:41,049 --> 00:09:41,370
that.
138
00:09:41,370 --> 00:09:43,929
You can write, pick securities better.
139
00:09:44,264 --> 00:09:49,065
Maybe you go into your stock allocation and
pick stocks better to beat the market or you do
140
00:09:49,065 --> 00:09:50,105
that in your bond allocation.
141
00:09:50,105 --> 00:09:52,264
You can do tactical asset allocation, right?
142
00:09:52,264 --> 00:09:54,105
Switch between stocks and bonds.
143
00:09:54,184 --> 00:09:58,459
But these approaches typically rely on one
person winning and one person losing.
144
00:09:58,459 --> 00:09:58,779
Right?
145
00:09:58,779 --> 00:10:01,899
They're more typically relying on behavioral
phenomena.
146
00:10:01,980 --> 00:10:06,779
What's really interesting about merger
arbitrage as a strategy is that we really think
147
00:10:06,779 --> 00:10:08,299
it's a risk premium.
148
00:10:08,860 --> 00:10:13,865
That by investing in merger arbitrage, you
should expect to earn a return because you are
149
00:10:13,865 --> 00:10:14,985
bearing a risk.
150
00:10:15,065 --> 00:10:18,264
The same way you should expect to earn a return
for bearing credit risk.
151
00:10:18,264 --> 00:10:21,464
The same way you should expect to earn a return
for just bearing bonds.
152
00:10:21,464 --> 00:10:22,745
The bond risk premium.
153
00:10:22,745 --> 00:10:23,784
Or expect to earn a return.
154
00:10:23,970 --> 00:10:25,009
Do equities go up?
155
00:10:25,009 --> 00:10:26,370
The equity risk premium.
156
00:10:26,449 --> 00:10:32,289
And so for us from a conviction perspective,
right, what do we think will continue to work
157
00:10:32,289 --> 00:10:33,250
over the long run?
158
00:10:33,250 --> 00:10:38,985
We have very high conviction in risk premium,
and we think merger arbitrage is a very strong
159
00:10:38,985 --> 00:10:42,825
risk premium from both an empirical and
theoretical basis.
160
00:10:42,825 --> 00:10:49,464
And so when we look at continuing to diversify
our portfolio or adding novel return streams on
161
00:10:49,464 --> 00:10:54,799
top of our portfolio, to me it makes a lot more
sense to try to focus on those areas that we
162
00:10:54,799 --> 00:11:00,240
really think are risk premia before we start to
explore these other approaches to beat the
163
00:11:00,240 --> 00:11:00,559
market.
164
00:11:05,254 --> 00:11:11,735
When you look at merger arbitrage as a
category, you don't tend to see a huge amount
165
00:11:11,735 --> 00:11:15,735
of allocation to merger arbitrage among
financial advisors.
166
00:11:15,735 --> 00:11:20,220
Again, goes back to this problem of clients
aren't starting with a blank canvas.
167
00:11:20,220 --> 00:11:23,980
They're typically mentally behaviorally
anchored to what's happening with stocks and
168
00:11:23,980 --> 00:11:24,620
bonds.
169
00:11:25,019 --> 00:11:30,379
And if you can't keep up with stocks and bonds,
which merger arbitrage has not kept up with
170
00:11:30,379 --> 00:11:34,414
stocks and bonds, they typically just want to
get rid of it because it tends to be higher
171
00:11:34,414 --> 00:11:36,654
costs, less tax efficient, more opaque.
172
00:11:36,654 --> 00:11:38,415
It's just not something they understand.
173
00:11:38,654 --> 00:11:44,735
And so to me, what's so compelling about our
approach is you're getting the core bonds back,
174
00:11:45,649 --> 00:11:49,409
you're stacking the merger arb, this novel risk
premium on top.
175
00:11:49,409 --> 00:11:53,329
I think it's a very compelling risk premium
over the long run and what you're creating
176
00:11:53,329 --> 00:11:56,370
through that combination is something that's
gonna look a lot like investment grade
177
00:11:56,370 --> 00:12:01,324
corporate bonds to a client and that's
something that I think clients can hold on to
178
00:12:01,324 --> 00:12:04,845
for the long run while harvesting those
diversification benefits.
179
00:12:09,084 --> 00:12:12,605
When we're looking to build a portfolio, we
should be looking for that breadth,
180
00:12:12,605 --> 00:12:15,059
particularly that breadth risk premium.
181
00:12:15,059 --> 00:12:15,539
Right?
182
00:12:15,539 --> 00:12:17,779
People allocate to stocks because there's a
risk premium.
183
00:12:17,779 --> 00:12:19,459
They allocate to bonds because there's a risk
premium.
184
00:12:19,459 --> 00:12:22,419
They allocate to corporate bonds because
there's a credit risk premium.
185
00:12:22,820 --> 00:12:28,820
Merger arbitrage is very defensibly to me a
risk premium, and yet almost no one has it in
186
00:12:28,820 --> 00:12:35,035
their portfolio Because I think the way it's
typically packaged, which is basically a cash
187
00:12:35,035 --> 00:12:41,355
plus strategy, you're earning t bills plus the
merger risk premium, is just less especially
188
00:12:41,355 --> 00:12:44,950
over the last decade where t bills were giving
you nothing, is just less attractive from a
189
00:12:44,950 --> 00:12:46,149
total return basis.
190
00:12:46,629 --> 00:12:50,070
And and from that line item perspective is
gonna stick out to clients.
191
00:12:50,389 --> 00:12:55,110
When you take the return stacking approach like
we do, where we carve off the risk premium
192
00:12:55,110 --> 00:12:59,750
element of merger arbitrage and stack it on top
of the bonds, and you put that in a single line
193
00:12:59,750 --> 00:13:05,695
item, I think the return of that line item is a
lot easier to hold for investors over the long
194
00:13:05,695 --> 00:13:10,254
run, is going to rhyme a lot more with what
they expect to see in their portfolio, but
195
00:13:10,254 --> 00:13:14,980
still gives you that potentially really
beneficial breadth, right?
196
00:13:14,980 --> 00:13:18,820
Expanding the set of risk premium that a client
is allocated to.
197
00:13:18,820 --> 00:13:24,340
And so again, particularly in an environment
like today where you are seeing credit spreads
198
00:13:24,340 --> 00:13:31,644
compressed to multi decade lows, I think it's a
timely period to explore how you can diversify
199
00:13:31,644 --> 00:13:33,325
beyond the credit risk premium.
200
00:13:37,324 --> 00:13:42,269
These ideas that we're bringing are nothing new
or novel and there's something that's existed
201
00:13:42,269 --> 00:13:46,110
in the institutional space and been used with
great success for a long time.
202
00:13:46,110 --> 00:13:50,110
And so all we're hoping to do is take that idea
and and bring it down and make it available,
203
00:13:50,110 --> 00:13:52,910
for lack of a better phrase, to democratize
access to the idea.
204
00:13:52,910 --> 00:13:56,350
So going back to this idea of how do you find
diversification in your portfolio, we'll use
205
00:13:56,350 --> 00:13:58,825
the cliche example of a 6040 investor.
206
00:13:59,225 --> 00:14:03,625
A lot of people over the last decade have
pushed from moving from a 60% stock, 40% bond
207
00:14:03,625 --> 00:14:08,585
portfolio to something that's 50% stock, 30%
bond, 20% alternative.
208
00:14:08,904 --> 00:14:14,379
And it may look great on paper over a multi
decade period, but the reality is behavioral
209
00:14:14,379 --> 00:14:16,139
time is a lot more like dog years.
210
00:14:16,379 --> 00:14:21,500
You underperform for three years in a row and
to the client it's gonna feel like 21, and it's
211
00:14:21,500 --> 00:14:26,059
hard for them to stick with and it's why you
tend to see these really big measured behavior
212
00:14:26,059 --> 00:14:31,065
gaps in these alternative asset class
categories where the investment return tends to
213
00:14:31,065 --> 00:14:36,504
be several 100 basis points higher than the
realized investor return, because they end up
214
00:14:36,504 --> 00:14:40,024
performance chasing in and out of these
categories, because it's hard for them to stick
215
00:14:40,024 --> 00:14:40,184
with.
216
00:14:41,050 --> 00:14:46,410
Return stacking is just an idea that came from
the institutional space called Portable Alpha
217
00:14:46,410 --> 00:14:51,210
that's been around for forty, forty five years,
and what we're ultimately trying to do is use
218
00:14:51,210 --> 00:14:56,914
the capital efficiency that exists in a lot of
these strategies, whether it's managed futures
219
00:14:56,914 --> 00:15:03,075
or merger arbitrage or carry or whatever it is,
to layer those alternative strategies on top of
220
00:15:03,075 --> 00:15:04,434
the core stocks and bonds.
221
00:15:04,514 --> 00:15:08,595
So that instead of going from a sixty forty to
a fifty thirty twenty, they can go from a sixty
222
00:15:08,595 --> 00:15:10,799
forty to a sixty forty twenty.
223
00:15:11,039 --> 00:15:11,279
Right?
224
00:15:11,279 --> 00:15:15,919
And now the number sums up to more than a 100
and they're adding these alternatives as an
225
00:15:15,919 --> 00:15:20,480
overlay to the core stocks and bonds that they
expect to retain, which can help reduce the
226
00:15:20,480 --> 00:15:24,745
tracking error of their portfolio to those
things that clients are most behaviorally
227
00:15:24,745 --> 00:15:25,785
sensitive to.
228
00:15:34,425 --> 00:15:39,560
If you're enjoying the podcast, please consider
heading over to your favorite podcast platform
229
00:15:39,560 --> 00:15:43,800
and leaving us a rating or review and sharing
us with friends or on social media.
230
00:15:44,120 --> 00:15:46,759
It helps new people find us and helps us grow.
231
00:15:47,000 --> 00:15:51,879
Finally, if you'd like to learn more about our
extensive research on the concept of return
232
00:15:51,879 --> 00:15:55,625
stacking, please do head over to
returnstacked.com.