תעתיק 🔗
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Hey, everyone.
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Corey Hofstein here.
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I wanna personally invite you to an event
that's all about rethinking portfolio
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construction.
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On October 8, we're hosting the return stacking
symposium at Cboe Global Markets in Chicago.
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It's a one day in person deep dive into capital
efficient strategies, and we're featuring
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speakers like Jonathan Glidden, CIO of Delta
Airlines, Patrick Casley from One River, and
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Mark Horbul, managing director of the
Systematic Strategies Group at Canada Pension
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Plan.
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This is your chance to hear directly from the
institutional allocators leading the charge on
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portable alpha and return stacking.
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But space is limited, so head over to
returnstacked.com/symposium to learn more and
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register.
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Hope to see you there.
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Hello, and welcome to the Get Stacked
Investment Podcast, where we delve into the
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exciting new world of return stacking.
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Join us as we break down complex financial
concepts into accessible insights, speak with
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leading experts in the space, and analyze real
world applications for return stacking.
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GetStacked is here to help you break out of the
traditional portfolio construction mold and get
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you to start thinking differently about the
path investment.
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Corey Hofstein is the co founder and chief
investment officer of Newfound Research, and
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Rodrigo Gordillo is the president and portfolio
manager of Resolve Asset Management Global.
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Due to industry regulations, we will not
discuss any funds managed or sub advised by
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these firms on the podcast.
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All opinions expressed by podcast participants
are solely their own opinion and do not reflect
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the opinion of neither Newfound Research or
Resolve Asset Management Global.
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This podcast is for informational purposes only
and should not be relied upon as a basis for
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investment decisions.
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Clients of these firms may maintain positions
and securities discussed in this podcast.
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For more information, visit returnstack.com.
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When a company, when there's an announcement
that one company is going to buy another, if
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this is a public company that's trading, the
company that's getting acquired, typically its
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share price is going to jump up towards the
announced price, but it typically doesn't go
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all the way.
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There's usually a spread left and that spread
is going to represent two things.
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One, it's going to represent the time value of
money.
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The deals typically aren't closing imminently.
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They're typically closing say an expected deal
time might be six to twelve months, and so the
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market's going to build in some sort of time
value of money for that deal to close.
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The other thing the market is going to price in
is the expected expectation of any deal break.
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We have very strong laws about mergers and
acquisitions in The US, but there's still a
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probability that a deal might fall apart for
capital reasons or deal might fall apart
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because of regulatory reasons.
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And so that represents deal break risk and
that's going to be baked into the premium as
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well.
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And so you can almost think of how far the deal
jumps, how far the stock price jumps from where
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it was trading to the announced deal prices, a
pseudo probability of how much the market
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thinks the deal is likely to get done with some
time value money baked in there.
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And so what merger arbitrage does is it says
after the deal has been announced, we are going
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to buy into that acquired company.
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If it's an all cash deal, if it's a cash plus
stock deal, we're going to buy into that
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company and short the stock of the acquirer, if
it's a public company, and then we're going to
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try to capture that remaining spread over time.
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It's less an arbitrage in the sense of a true
arbitrage.
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I like to think of it as a risk premium, right?
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A lot of those investors who are along for the
ride got that initial jump.
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There's a little bit of juice left to squeeze
in that spread and so when you're stepping in
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at that price that you are taking on the risk
that the deal could fall apart, you're taking
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on the risk that the deal might take longer
than the market's expecting And so by taking on
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those
Load full transcript
risks, you should earn a risk premium.
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So a well diversified M and A portfolio in the
public markets, once these deals are announced,
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should look very much like a mix between a
duration, a low duration portfolio, you're
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getting paid compensated for that time value
money premium and a little bit of something
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that looks a little bit like credit risk.
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It's not perfectly credit risk, but it's credit
risk adjacent and it's a different unique risk
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premium that you can earn.
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There's two ways I'd want to answer this.
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One is an evergreen answer, right?
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When we're building portfolios, I think it's
always prudent to be looking to diversify
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across as many unique risk premia as possible.
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When we look at the returns of a merger ARB
strategy, it's lowly correlated to bonds.
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It's got about a correlation point five to
equities, a correlation of about point five to
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the credit risk premium.
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And so as we're looking to just further
diversify our portfolios structurally, I think
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it's a great evergreen allocation.
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At this point in time, we're in an environment
where credit spreads are very thin.
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And so for more conservative investors who have
a lot of investment grade corporate bond
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exposure or even high yield bond exposure, the
question you have to ask is, we being fairly
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compensated for the risk we're taking?
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Particularly if there is a potential hard
landing coming around the corner from an
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economic perspective.
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I'm not going to prognosticate on that, but
when you have credit spreads this thin, the
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margin for error is quite low.
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And so one of the things we're talking a lot
about is saying, what if you took the merger
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risk premium and put it on top of treasuries?
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And what you end up with is something that over
the long run looks a lot like a corporate bond
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return profile, but the excess return that
you're earning above the treasuries isn't
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coming from credit risk, it's coming from deal
break risk.
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And again, there's some low correlation there.
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There is some similarities in certain markets,
but it
is its own unique risk premium.
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And so we think it makes a great diversifier to
corporate bonds in an environment like we're in
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today.
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The expectation is typically there is a bit of
cyclicality to merger arbitrage.
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Right?
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People typically think, oh, there's a big
recession, right?
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That's bad for M and A.
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That is true to a certain extent and that's
where you do tend to see a little bit of
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correlation between merger arbitrage and credit
and equities.
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M and A deals might dry up, They might take
longer for people to get the financing, but we
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have very strong M and A laws in this country.
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The example I always give is Elon Musk buying
Twitter, now X.
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Right?
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He made a proposal in a somewhat joking manner
and then Delaware law forced him to buy
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Twitter.
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Right?
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So it's very hard to get out of these deals
once they're announced.
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And so when you look at a diversified merger
arbitrage portfolio, you're talking about a
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diversified set of idiosyncratic risks versus
when you look at credit, you tend to be looking
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at something that is far more cyclical and
tends to have a lot more correlation to equity
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markets because it's a pseudo proxy for what's
happening in the economy.
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And so it's not to say there isn't some sort of
economic similarity to them.
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Again, that correlation is about a point five,
but it's not perfect and you tend to find that
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M and A strategies, merger arbitrage strategies
have far less downside correlation to equities
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than credit does.
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I think what you find with a traditional merger
arb strategy, if you're just buying an off the
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shelf merger arb strategy, this is typically
like a short duration bond fund.
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The way we're putting together our bonds and
merger arbitrage strategy is it's going to be
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something much more an intermediate term fund.
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You're just generic investment grade credit
strategy.
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We are taking a diversified portfolio of
treasury exposure from two year, five year, ten
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year out to US long bond treasury exposure and
then stacking on top of that the merger
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arbitrage risk premium.
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That's our ambition at least.
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And so when you put those two things together,
you get something that looks a lot more like
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investment grade corporate bonds.
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And so that's where we would recommend people
fund this allocation from it.
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They should sell some of their core investment
grade corporate bonds, buy some of a portfolio
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like this, the bonds plus merger arbitrage
strategy, And in doing so, we think over the
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long run, you get a very similar return
profile.
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I actually think merger arbitrage has
historically been more attractive than the
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credit risk premium.
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But let's say it's the same.
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The benefit there really is then the
diversification, right?
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That you're just adding yet another risk
premium to your portfolio and helping spread
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your bets into unique places that you should
get paid for allocating your money.
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When we think about beating the market, there's
very few ways in which you can actually do
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that.
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You can write, pick securities better.
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Maybe you go into your stock allocation and
pick stocks better to beat the market or you do
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that in your bond allocation.
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You can do tactical asset allocation, right?
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Switch between stocks and bonds.
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But these approaches typically rely on one
person winning and one person losing.
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Right?
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They're more typically relying on behavioral
phenomena.
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What's really interesting about merger
arbitrage as a strategy is that we really think
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it's a risk premium.
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That by investing in merger arbitrage, you
should expect to earn a return because you are
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bearing a risk.
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The same way you should expect to earn a return
for bearing credit risk.
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The same way you should expect to earn a return
for just bearing bonds.
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The bond risk premium.
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Or expect to earn a return.
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Do equities go up?
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The equity risk premium.
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And so for us from a conviction perspective,
right, what do we think will continue to work
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over the long run?
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We have very high conviction in risk premium,
and we think merger arbitrage is a very strong
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risk premium from both an empirical and
theoretical basis.
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And so when we look at continuing to diversify
our portfolio or adding novel return streams on
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top of our portfolio, to me it makes a lot more
sense to try to focus on those areas that we
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really think are risk premia before we start to
explore these other approaches to beat the
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market.
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When you look at merger arbitrage as a
category, you don't tend to see a huge amount
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of allocation to merger arbitrage among
financial advisors.
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Again, goes back to this problem of clients
aren't starting with a blank canvas.
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They're typically mentally behaviorally
anchored to what's happening with stocks and
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bonds.
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And if you can't keep up with stocks and bonds,
which merger arbitrage has not kept up with
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stocks and bonds, they typically just want to
get rid of it because it tends to be higher
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costs, less tax efficient, more opaque.
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It's just not something they understand.
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And so to me, what's so compelling about our
approach is you're getting the core bonds back,
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you're stacking the merger arb, this novel risk
premium on top.
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I think it's a very compelling risk premium
over the long run and what you're creating
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through that combination is something that's
gonna look a lot like investment grade
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corporate bonds to a client and that's
something that I think clients can hold on to
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for the long run while harvesting those
diversification benefits.
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When we're looking to build a portfolio, we
should be looking for that breadth,
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particularly that breadth risk premium.
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Right?
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People allocate to stocks because there's a
risk premium.
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They allocate to bonds because there's a risk
premium.
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They allocate to corporate bonds because
there's a credit risk premium.
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Merger arbitrage is very defensibly to me a
risk premium, and yet almost no one has it in
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their portfolio Because I think the way it's
typically packaged, which is basically a cash
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plus strategy, you're earning t bills plus the
merger risk premium, is just less especially
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over the last decade where t bills were giving
you nothing, is just less attractive from a
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total return basis.
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And and from that line item perspective is
gonna stick out to clients.
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When you take the return stacking approach like
we do, where we carve off the risk premium
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element of merger arbitrage and stack it on top
of the bonds, and you put that in a single line
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item, I think the return of that line item is a
lot easier to hold for investors over the long
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run, is going to rhyme a lot more with what
they expect to see in their portfolio, but
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still gives you that potentially really
beneficial breadth, right?
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Expanding the set of risk premium that a client
is allocated to.
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And so again, particularly in an environment
like today where you are seeing credit spreads
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compressed to multi decade lows, I think it's a
timely period to explore how you can diversify
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beyond the credit risk premium.
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These ideas that we're bringing are nothing new
or novel and there's something that's existed
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in the institutional space and been used with
great success for a long time.
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And so all we're hoping to do is take that idea
and and bring it down and make it available,
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for lack of a better phrase, to democratize
access to the idea.
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So going back to this idea of how do you find
diversification in your portfolio, we'll use
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the cliche example of a 6040 investor.
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A lot of people over the last decade have
pushed from moving from a 60% stock, 40% bond
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portfolio to something that's 50% stock, 30%
bond, 20% alternative.
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And it may look great on paper over a multi
decade period, but the reality is behavioral
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time is a lot more like dog years.
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You underperform for three years in a row and
to the client it's gonna feel like 21, and it's
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hard for them to stick with and it's why you
tend to see these really big measured behavior
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gaps in these alternative asset class
categories where the investment return tends to
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be several 100 basis points higher than the
realized investor return, because they end up
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performance chasing in and out of these
categories, because it's hard for them to stick
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with.
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Return stacking is just an idea that came from
the institutional space called Portable Alpha
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that's been around for forty, forty five years,
and what we're ultimately trying to do is use
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the capital efficiency that exists in a lot of
these strategies, whether it's managed futures
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or merger arbitrage or carry or whatever it is,
to layer those alternative strategies on top of
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the core stocks and bonds.
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So that instead of going from a sixty forty to
a fifty thirty twenty, they can go from a sixty
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forty to a sixty forty twenty.
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Right?
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And now the number sums up to more than a 100
and they're adding these alternatives as an
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overlay to the core stocks and bonds that they
expect to retain, which can help reduce the
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tracking error of their portfolio to those
things that clients are most behaviorally
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sensitive to.
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If you're enjoying the podcast, please consider
heading over to your favorite podcast platform
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00:15:39,560 --> 00:15:43,800
and leaving us a rating or review and sharing
us with friends or on social media.
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It helps new people find us and helps us grow.
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Finally, if you'd like to learn more about our
extensive research on the concept of return
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00:15:51,879 --> 00:15:55,625
stacking, please do head over to
returnstacked.com.