บทถอดความฉบับเต็มของ Stacking Merger Arbitrage with Corey Hoffstein

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.