Gideon King’s Loeb Arbitrage Fund had a tough run in the second quarter. The event-driven hedge fund was up by only 0.55% in 2Q2014, which barely edged up the return for the year to +0.64%. Other funds who seek to capture profits from event-driven arbitrage did somewhat better than Loeb Arb in the past quarter. However, the return on Credit Suisse Merger Arbitrage Liquid Index is down 4.3% YTD.
Funds like John Paulson‘s Enhanced Fund were up 11% through the end of June for the year, whereas Paulson International was up 5.4% over the same period. TIG Arbitrage Enhanced Fund gained roughly 7% in the first half. Other hedge funds stumbled, Lion Fund was down 0.13% YTD through June, whereas Gabelli Associates Limited took in a gain of just 2.2% in the same period, according to data from Hedge Weekly.
Tax inversion and hedge fund crowding
King spoke of the stricter regulations that could curb M&A activity. He was referring to U.S. government’s plan to crackdown on the tax inversion loophole that allows U.S. companies to domicile in foreign countries after a merger and thus reduce their tax burden. This has gotten hedge funds worried, as they have been profiting from the cross-industry global consolidation wave.
King said that investors have put outsized bets on companies like AstraZeneca plc (ADR) (NYSE:AZN) and T-Mobile US Inc (NYSE:TMUS). These concentrated positions are enforcing arbitrage when bad news hits the company which then aggravates the fall. Carlson Capital also talked about hedge fund crowding and its adverse effects in their quarterly letter.
Loeb Arbitrage on Extendicare’s worth
Loeb Arbitrage talked about its long position in Extendicare Inc. (TSE:EXE), a company that provides services to the elderly in a recent letter. The letter said that 67% of the revenue generated by Extendicare comes from North America. Extendicare has a market cap of CAD850 million and the stock trades at 10x forward EBITDA. The company had announced that it intended to spin-off its underperforming U.S. unit. King said that such a transaction would highlight the value of its Canadian unit which has been doing well.
Extendicare’s plans were put on hold as U.S. Department of Justice conducted an investigation on Medicare and Medicaid fraud across the whole industry between 2010-2013. The investigation ended with Extendicare settling with the U.S. government for a mere $38 million last month. In King’s opinion, Extendicare should be worth CAD10-12 million after it separates the U.S operations.
Loeb Arbitrage Fund is maintaining low exposure to credit as it believes the asset class is overpriced. With its arbitrage-focused strategy, the fund will benefit as dislocation rises in companies that are undergoing M&A activity. King said that the M&A volume is bound to go higher in future and the fund is well-positioned to invest in suitable opportunities.