Little known hedge fund strategy now on the radar

Event-driven is one of the least recognised hedge fund strategies and yet, over the long term, 25 per cent of hedge fund assets are allocated to it. Its diversification benefits from mainstream indices are the principal reason for its prevalence in hedge fund portfolios.

Carl Ludwigson, associate director at Paamco, which runs a $10bn multi-strategy fund, says: "We see a move towards more event-driven strategies because they can extract idiosyncratic risk and less market-driven returns."

...

Although returns are respectable, there are fears that bread and butter event-driven trades are becoming overcrowded as M&A volumes tail off. The larger funds have little choice but to take part in the biggest transactions even if the pay-off is poor relative to the risk of the deal not completing. The recent failures of the NewsCorp bid for BSkyB, and BHP Billiton's attempted takeover of Potash Corporation, highlight the tail-risk inherent in the strategy: short positions in the acquirers were punished severely in both these cases.

...

In difficult economic climates, where M&A is scarce, there are opportunities in strategies that can produce returns from distressed situations, such as post-reorganisation equities. This is typically where a company has emerged from administration and the debt has been converted to equity. The company may have fallen off the radar of analysts while it was in administration so is effectively de-rated. Mr Ludwigson notes that re-rating often takes place in time: "The re-listing of the stock and the addition of Street coverage can mean the story becomes more appreciated by the market," he says.