Tag Archives: mergers and acquisitions

Hedge Fund Trading Styles and Strategies Uncovered

There are four broad styles of hedge funds and multiple strategies beneath each style which are discussed at length in the book Hedge Funds Demystified by Scott Frush. This article summarises the four broad hedge fund styles and provides an insight into the management of hedge funds.

In many cases, Hedge Fund managers combine strategies from the styles below but regardless of the strategy, each has the aim of generating attractive absolute returns. This is the fundamental difference between most investing funds (eg mutual funds) and hedge funds; hedge funds aim to deliver absolute returns in both a bull and a bear market.

The following are the primary strategies employed by hedge funds (such as the infamous Long Term Capital Management Fund), grouped by style:

Tactical (also known as directional)

  1. Macrocentric – Strategy where the hedge fund manager invests in securities that capitalise on domestic and global market opportunities. Trading strategies are generally systematic or discretionary; systematic traders tend to use price and market-specific information (often based on technical trading rules) to make trading decisions, while discretionary managers use a judgmental approach regarding differences between current financial market valuations and what is perceived as the ‘correct’ or fundamental valuation.
  2. Managed futures - Strategy where the hedge fund manager invests in commodities derivatives with a momentum focus, hoping to ride the trend to attractive profits.
  3. Long/short equity - Strategy where the hedge fund manager combines long holdings of securities that are expected to increase in price with short sales of securities that are expected to decrease in price. Long/short portfolios are directional – that is, the investment strategy is based on the manager’s expectation of future movements in the overall market – and may be net long or net short. Short positions are expected to add to the return of the portfolio, but may also act as a partial hedge against market risk. However, long/short portfolios tend to be quite heavily concentrated and thus the effectiveness of the short positions as a hedge against market risk may be limited.
  4. Sector-specific – Strategy where the hedge fund manager invests in markets in specific sectors by going long, short, or both.
  5. Emerging markets – Strategy where the hedge fund manager invests in less developed, but emerging markets.
  6. Market timing – Strategy where the hedge fund manager either times mutual fund buys and sells or invests in asset classes that are forecast to perform well in the short term.
  7. Selling short – Strategy where the hedge fund manager sells short borrowed securities with the aim of buying them back in the future at lower prices thus making a profit.

Relative value (also called arbitrage)

  1. Convertible arbitrage - Strategy where the hedge fund manager takes advantage of perceived price inequality with convertible bonds and the associated equity securities.
  2. Fixed-income arbitrage - Strategy where the hedge fund manager purchases a fixed-income security and immediately sells short another fixed-income security to minimize market risk and profit from changing price spreads. This was one of the key strategies employed by Long Term Capital Management before its demise. This is known as a non-directional spread trade. Managers take equal long and short positions in two related securities when their prices diverge from their typical relationship. Positive returns are generated when the prices of the two securities re-converge. Because arbitrage opportunities can be limited and the returns from these trades tend to be quite small, arbitrage strategies often employ higher leverage than other funds in an attempt to maximise the profit from exploiting these perceived mis-pricings.
  3. Equity-market-neutral - Strategy where the hedge fund manager buys an equity security and sells short a related equity index to offset market risk. An example of this would be buying Coke stock and selling Pepsi short. Market neutral managers attempt to eliminate market risk by constructing portfolios of long and short positions which, when added together, will be largely unaffected by movements in the overall market. Positive returns are generated when the securities which are held long outperform the securities which are held short. Market neutral portfolios tend to be more heavily leveraged than the long/short directional portfolios discussed above.

Event-driven

Event-driven strategies seek to take advantage of opportunities created by significant corporate transactions such as mergers and takeovers. A typical event-driven strategy involves purchasing securities of the target firm and shorting securities of the acquiring firm in an announced or expected takeover. Profits from event-driven strategies depend on the manager’s success in predicting the outcome and timing of the corporate event. Event-driven managers do not rely on market direction for results; however, major market declines, which might cause corporate transactions to be repriced or unfinished, may have a negative impact on the strategy.

  1. Distressed securities - Strategy where the hedge fund manager invests in the equity or debt of struggling companies at steep discounts to estimated values.
  2. Reasonable value – Strategy where the hedge fund manager invests in securities that are selling at discounts to their estimated values as a result of being out of favor or being relatively unknown in the investment community.
  3. Merger arbitrage - Strategy where the hedge fund manager invests in merger-related situations where there are unique opportunities for profit.
  4. Opportunistic events - Strategy where the hedge fund manager invests in securities given short-term event-driven situations considered to offer temporary profitable opportunities. An example of this may be if a piece of legislation is about to change and particular companies are likely to benefit.

Hybrid

  1. Multistrategy - Strategy where the hedge fund manager employs two or more of the above strategies at one time. Managers may elect to employ a multi-strategy approach in order to better diversify their portfolio or to avoid constraints on their investment opportunities.
  2. Funds of funds - Strategy where the hedge fund manager invests in two or more stand-alone hedge funds rather than directly investing in securities.
  3. Values-based - Strategy where the hedge fund manager invests according to certain personal values and principles.

Mergers and Acquisitions Career; What is involved and is it for you?

Mergers and Acquisitions

To many in the finance industry and the general population, mergers and acquisitions work can seem very glamorous and high profile. The mergers and acquisitions group (known as M&A) provides advice to companies that are buying another company or are themselves being acquired.

At the same time, the work leading up to the headline-grabbing multibillion-dollar acquisition can involve a great effort to crunch all the numbers, perform the necessary due diligence, and work out the complicated structure of the deal. The guide noted that one insider said, “You have to really like spending time in front of your computer with Excel.”

Often, the mergers and acquisitions team will also work with a Corporate Finance industry group to arrange the appropriate financing for the transaction (usually done through a debt or equity offering).

In many cases, all this may happen on a very tight timeline and under extreme secrecy and pressure. Mergers and acquisitions is often a subgroup within corporate finance; but in some firms, it is a stand-alone department. Mergers and acquisitions can be one of the most demanding groups to work for.

What do Mergers and Acquisitions Groups do?

  • Advise firms on merger and acquisition strategies
  • Determine target company valuations using a number of different valuation techniques
  • Help the target of a hostile acquisition arrange a defensive strategy where appropriate
  • Conduct due diligence on a target or acquiring company (this includes examining the financial results and other business factors that will affect the value of an acquisition)
  • Negotiate price, terms, and conditions of an acquisition or merger
  • Work with the other company’s advisory team and the lawyers to structure the deal

A Career in Mergers and Acquisitions; Who Does Well?

Like corporate finance, mergers and acquisitions requires detail-oriented thinking, a knack for using numbers to understand business patterns, problem-solving skills, an ability to think critically about the numbers you’re working with. Add to this, excellent communication and people skills and you have a potential mergers and acquisitions candidate.

Also like corporate finance, lawyers, MBAs, and experience candidates with specific industry knowledge make good mergers and acquisitions candidates. Many entry-level candidates try to get an internship to increase their chances of eventually getting full-time offers and the guide discusses methods of attaining these internships. Selection is competitive to say the least.

Investment Banking Interview Questions and Tips can be found in my article on Investment Banking Interview Questions and Tips.


Mergers and Acquisitions Job Tips

The M&A department usually recruits under the Corporate Finance or investment banking umbrella, although within the group you may find further specialization along industry lines. The work here tends to be intense and very deal-focused, and the hours are unpredictable.

“You might be staffed on five transactions and not much is happening. Then one turns live, and you have to cancel your weekend plans,” says an insider. “Or you could be very busy, and the next day something happens and work gets pushed back a week and suddenly your weekend is free.”

The job provides an excellent introduction to the high-stakes, power centric movement of the corporate world. It is common for insiders to report that personal ambition is a big success factor in mergers and acquisitions.

“You can learn the technical skills like accounting and modeling,” says one first-year associate. “It’s not so easy to learn how to be driven and to take responsibility, to own the deal.”

If you are the type of person to be depressed by the thought of spending 3 or more weeks of your life crunching numbers for a deal that may never happen, the guide suggested that there may be better alternatives in Corporate Finance.

Example of a Mergers and Acquisitons Deal

IBM Corporation decides it has an opportunity to strengthen its hardware business by acquiring an innovative developer of communications software. It approaches an investment bank to get advice on the potential deal. The bankers help IBM secretly value the target company’s assets and the potential value of its products to IBM (which may be higher than their current value because of the opportunities to link with IBM hardware and because of Big Blue’s marketing muscle).

The mergers and acquisitions group then develops IBM’s acquisition strategy and makes contact with the target company. Once the offer is made, the target company will consult its own investment bankers. They help the target evaluate IBM’s proposal, determine various strategies for defending against or negotiating with IBM, and work out a deal that will be in the best interest of the company’s shareholders. After some back and forth, the sides agree on a price (usually a combination of equity and debt), sign the documents, and merge.

I have sourced the majority of the information above from the Wetfeet Insider Guide to Careers in Investment Banking; click here to read about what is involved in a career in investment banking.

What is involved in a career in investment banking ?

investment banking

After reading The Accidental Investment Banker by Jonathan Cree, I decided my first blog on investment banking and corporate finance was due.

From my understanding of investment banking, many people simply don’t understand it. Is it banking? Is it investing? Is it Gordon Gecko in the movie Wall Street or is he a trader? What is the difference between an investment banker and an equity trader? What do investments bankers actually do?

One finance degree short of an answer, it took me a fair while to truly come to grips with the concept of investment banking. However, now that I have, I feel the short summary below will give a very good indication to those considering a career in investment banking or those wishing to understand investment banking better.

What is investment banking and what do investment bankers do?

As companies grow, they need capital. In many cases, in order to raise capital and for other related advisory services, companies go to investment banks. Investment banks provide a range of services relating to the raising of capital and act as advisors to the world’s corporate leaders… Continue reading What is involved in a career in investment banking ?