What might sound like a new name in the event driven world, is anything but a stranger in institutional investing. “The genesis of Bantleon’s event driven equity strategies lay in the search for diversification from pure equity and bond beta amid continuing yield compression. This was a logical step in Bantleon’s 30 years of reinvention since the EUR 5 billion asset manager was founded by banker Joerg Bantleon in 1991,” says Board Member and Head of Liquid Alternatives, Sebastian Finke. “Within our long-term analysis of the capital market environment, we forecasted that risk premia from conventional equity and bond portfolios at some point would not be enough to fulfil the requirements for return and diversification of our institutional client base.” Having always been focused on capital preservation coupled with attractive returns, in 2017 the Swiss-German investment boutique hence expanded into liquid alternatives.
For that purpose, Finke was hired in 2017 to open the Munich office as the central hub for the company’s niche (alternative) equity strategies, including event driven/merger arbitrage, that fit the needs of Bantleon’s institutional clients. When recruiting the event driven team, he built on his prior career: “My background was in corporate M&A, working closely with investment bankers and lawyers. Hence, I knew the value-add a fundamental skillset can bring to the table for these strategies and mainly hired ex-M&A bankers who have lived and breathed corporate events on the sell and buy side,” says Finke.
Since launch, the strategy has been run by a team around Oliver Scharping, who started his career more than 10 years ago as an investment banker at Lazard. Later he worked on catalyst-driven situations at Sterling Strategic Value, a Europe-focused activist fund and had stints at Lee Robinson’s Altana Wealth and Quarz Capital – both of which are experienced generators of uncorrelated niche alpha. In 2018, Scharping turned down a role at a larger event driven outfit, keen to instead build his own team at Bantleon, where he immediately started managing a separate account. Within a few months it had attracted enough interest from investors to warrant establishing a UCITS flagship fund: the Bantleon Event Driven Equities fund was born. Co-portfolio manager Leonard Keller joined in 2020 and the research-focused duo is today supported by two traders working on the execution side.
The UCITS has now passed a two-year track record with average annualized returns over 7%, a Sharpe ratio above 1, and strategy AUM have surpassed EUR 125 million. “Our event driven strategy is one example of a niche strategy that offers unique risk/return characteristics with a marginal beta to equity markets that our institutional clients could not easily run by themselves,” says Finke.
Event driven is well suited to the next capital market phase, which will see lower equity market returns, more volatility, and be hostile for fixed income.
Sebastian Finke, Board Member and Head of Liquid Alternatives, Bantleon
The fund is a versatile, European-oriented event driven equity strategy with a heavy bias towards merger arbitrage that opportunistically also invests in SPACs, special situations and relative value and back-end situations. “It is designed to be an all-weather allocation for investors who take a longer-term view and prefer to get actively managed exposure to various sub-strategies throughout a full business cycle,” says Scharping.
Since launch, the fund has outperformed the HFRI-I Liquid Alternative UCITS Event Driven Index and surpassed its return target – despite launching in a period that was anything but easy for event-driven investors with a Covid-related spread dislocation in March 2020 and questions over many blockbuster deals. “Investors can also access sub-strategies through separately managed accounts, which make up two thirds of our strategy assets. Segregated accounts currently include a pure SPAC arbitrage strategy for a German insurer, a carve out of the pure merger arbitrage and special situations strategy for another client, and a strategy focused on the higher beta strategies for another investor who already has lower beta exposure,” explains Scharping. Around 90% of Bantleon’s clients are based in the German-speaking region and there is capacity in all sub-strategies.
The spectrum of event strategies reflects the breadth and depth of experience and inspiration that the managers have gained on the buy side, sell side and even at business school, where Scharping worked for activist fund Quarz Capital. His time at activist Sterling, added to his investment banking experience of advising tier one activists, and also provided a roadmap for unconventional idea generation: “Sterling is one of Europe’s oldest activist investors and takes significant concentrated positions in smaller and medium sized companies. We carried out very detailed due diligence and research on companies to assemble and synthesise a mosaic of all information, talking to experts about competitors, and meeting clients or potential customers”.
Scharping and Keller met in investment banking, which shaped their analytical approach to risk arbitrage: “We learned to run fundamental valuation and synergies in the labour-intensive ‘old-school’ way, to provide fundamental downside estimates based on deep bottom-up valuation. We emphasise valuation because we never know where the next deal break or Black Swan may come from. Other risk arbitrageurs see it more from a risk premium perspective,” says Scharping. The intensive research is possible partly because the team do not get distracted by operational matters. Scharping enjoys being part of a large institutional platform that provides the infrastructure and support that allows him and his team to focus on research and analysis.
Beyond risk arbitrage, Scharping’s time at asset manager Altana has inspired his opportunistic and holistic approach to event investing: “Altana’s founder, Lee Robinson [who Scharping considers a role model] was on the lookout for niche alpha every day, was very careful on risk reward, and had a laser like focus on creating cheap optionality. It is probably no coincidence that we both recently launched SPAC arbitrage funds within 2 weeks,” he says. Keller, whose experience also spanned SPACs in his last role at Harris Williams, has, like Finke, also worked on corporate M&A deal-making: “While at Barclays I was seconded to Deutsche Telekom’s corporate M&A team looking at public M&A where I saw from the inside why deals break in ways that are not publicly announced”.
The Bantleon Event Driven Equities fund has now passed a two-year track record with average annualized returns over 7%, a Sharpe ratio above 1, and strategy AUM have surpassed EUR 125 million
Ideas can also come from a network of specialist and local brokers: “We are filtering information from special situations desks at places like Goldman Sachs or Morgan Stanley, and from local brokers in France, Israel or Ireland. Recently an Irish analyst had different insights from larger banks on the UDG situation that got a higher bid this week. At the end of the day our edge comes more from a judgement advantage than an information advantage,” says Scharping.
Outside work, an important influence on Scharping was former US Treasury Secretary, Robert Rubin, and his book, In an Uncertain World. “I was fortunate enough to meet him at the SALT Las Vegas conference. He obviously started the whole risk arbitrage business at Goldman Sachs, which became their most successful unit, even more profitable than M&A, and he was certainly a major influence for myself and the whole arbitrage world as we know it today.”
Risk arbitrage is the bread-and-butter strategy that has consistently accounted for the largest capital allocation in the fund. Bantleon seek a more asymmetric risk/return profile both on traditional merger arbitrage deals and other sub-strategies including minority squeeze outs, de-listings and SPAC arbitrage, which may offer a better upside to downside ratio.
Many plain vanilla merger arbitrage deals are not overly attractive. “We are very selective on super safe deals with a tight rate of return because risk is often not linear – they might have too much tail risk. We would rather take a position with upside optionality, which we estimate from fundamental analysis of the target and potential synergies,” says Scharping.
Stressed transactions with bigger gross spreads can offer a better risk/reward, and Bantleon has used expert opinions to gauge deal break risk: “Roche’s offer for Spark Therapeutics in 2019 traded around a 10% gross spread, which implied a deal completion probability of only about 70%. We engaged with a former FTC lawyer to understand more about the FTC pull-and-refile process, and got colour on possible remedies for pipeline drugs that were thought to be crowded markets. We also engaged with a Swiss haemophilia and gene therapy expert for that deal. To research the Cypress Semiconductors/Infineon deal, we consulted an ex-Infineon employee in Munich to help us judge the transaction from a product perspective and form a better view on US national security regulatory concerns,” Scharping explains.
Trade structuring is also relevant: “We also try to increase convexity when possible through derivatives, especially in larger deals where the market cap is too big for the arbitrageurs to fully control spreads, such as currently the AMD/Xilinx deal or last year the LVMH/Tiffany deal,” he adds.
Active trading matters too. Rather than buying and holding until deals complete or break, Bantleon trades around spreads, especially around regulatory milestones. The team might occasionally short a deal where they judge the spread to be too tight, think the risk is skewed and see a low risk of counter-bids. “This is not so much an alpha source as a hedge for other deals that might have for example similar antitrust risk, and reverse deals rarely pass our risk framework,” says Scharping.
The Covid crisis provides a case study in proactive risk management. Bantleon assumes a beta of 0.05 for merger deals and this is normally observed. But in a crisis, all sorts of deal spreads can blow out: the worst peak to trough drawdown on Bantleon European Event Driven in March 2020 was 13%, using daily data, though by the end of the month losses were only 4.4%.
“We entered March with a very positive house view on the economy and elevated exposure to merger deals such as Tiffany and Cypress. We quickly cut exposure to deals with financial sponsors, which could be vulnerable to a credit market shutdown. We also cut deals in sectors that could be in trouble if Covid got worse, such as oil, gas, tourism and retail. We re-examined merger agreements and material adverse change (MAC) clauses from a pandemic perspective to see if acquirers could walk away based on precedents and case studies, and even fully exited some positions. We stress tested no vaccination scenarios and were positioned for a much worse summer and autumn than was seen. In hindsight if we had doubled down it would have been fantastic, but we did not know where it would end,” recalls Scharping.
While credit spreads were making new all-time lows in June 2021, merger arbitrage spreads remain elevated – as high as 8-9% annualised – for various reasons. They normally track risk free rates with some time lag, but higher interest rates in the US have not yet led to higher spreads. Instead, some deals are simply too large to absorb the pool of merger arbitrage capital, partly because mergers must compete with SPACs. And arbitrageurs once bitten by the blow out in March 2020 may now be twice shy to accept much tighter spreads.
We learned to run fundamental valuation and synergies in the labour-intensive ‘old-school’ way, to provide fundamental downside estimates based on deep bottom-up valuation.
Oliver Scharping, Lead Portfolio Manager, Bantleon
Bantleon judges that spreads are also wider due to regulatory risks and delays in the US and China: “A more hostile US regulator in the FTC is seen in Lina Kahn being appointed as Chair. We believe it is possible that she will set an aggressive and anti-business tone for the FTC’s antitrust enforcement agenda; such rather inexperienced and aggressive antitrust enforcement likely will lead to unfortunate outcomes, and increased scrutiny will lead to more and longer antitrust reviews. Her appointment, which to our knowledge, has only been cheered by fellow academics, doesn’t really inspire confidence in large cap (vertical) US mergers for the years to come,” says Scharping.
Meanwhile, Chinese regulator SAMR remains capacity constrained and slow – despite rumours that it is considering dividing its Anti-Monopoly Bureau into several bureaus in order to increase headcount to handle increasing workload. This for example, influences China-related spreads such as Maxim/Analog Devices or Magnachip,” he adds.
Already healthy spreads can be topped up by bidding wars. “We see overbid optionality as the theme du jour which is simultaneously priced into many transactions where relatively small targets worth $1-3 billion are sought by large competitors. Not least given the recent and surprising topping bids that emerged in Kansas City Southern, UDG, Siltronic, Coherent, Welbilt, etc. we are involved in some situations,” says Scharping.
Even deal breaks can sometimes lead to overbids: “Acacia opted to end a merger agreement on the basis that Cisco had failed to obtain Chinese regulatory approvals. Cisco initially denied this, and a lawsuit led to new terms and an offer of 115, much higher than the original price in the 70s. Typically, we would not size this type of situation very large though,” says Scharping.
The low incidence of deal breaks makes spreads even more compelling: “Since launch we have only had one unintended deal break, a Finnish deal – and two price cuts: Forescout Technologies and Tiffany. Our deal break rate of below 2% is well below the historical market average of 6-7% though the market environment has been good. Frankly, we expected many more breaks during Covid”.
Europe is Bantleon’s home and its sweet spot, leaving it somewhat isolated from fears about US and Chinese regulation. “European event driven trades appeal because European arbitrage is structurally less crowded. Some managers do not want to hedge currencies and Europe has different laws and corporate structures, such as Italian corporate actions, French politics, and complicated German takeover law,” says Scharping.
Germany’s unique laws provide selective opportunities. Scharping refers to these kinds of situations as endgame trades, and he believes “these set Bantleon apart from many other Anglo-Saxon or French event-driven peers”. “After a takeover tender offer German companies may pursue de-listings to increase their share of the free float. A domination agreement is possible above 75%, then there are two types of minority squeeze outs at 90% and 95%”. Bantleon can be involved in all these situations, which have different dynamics, but they need liquidity and a clear time frame. “We only invest in minority squeeze outs, such as MAN, where we see an imminent squeeze out. We think for example that Vodafone is motivated to squeeze out the Kabel Deutschland minorities in the not-too-distant future as MAN did. We definitely do not want to wait for years, though German law does provide for interest-like guaranteed dividend payments before a squeeze out. For instance, Kabel Deutschland is paying minority shareholders 3% per year and Osram 4%, based on what they agreed,” says Scharping.
The differences between Europe and the US are even greater for SPAC arbitrage. One advantage in Europe is a better ratio of SPACs to targets since Europe’s nascent SPAC market is at a much earlier stage. There were three SPACs in 2020 and nineteen in the prior 6 years, but as many as 20 are now expected in 2021. “We are closely monitoring all of them, providing feedback to syndicates, and have bought into eight already. We are doing as many background checks as possible with colleagues and contacts in venture capital and private equity. European SPACs are an evolving asset class, where investor education is needed to find the right structure and bring investors to the IPO. This is not just about the prospectus, but also other details – we do not yet have SPAC platforms as such in Europe. US SPACs currently offer more transparency and a clear path on presentations, terms and valuations,” says Keller. The relative opacity of European SPACs could provide an edge to those investors who can spend time understanding them.
Bantleon groups SPAC arbitrage within their risk arbitrage bucket, though it is arguably lower risk than many merger deals due to the escrow account feature. “SPACs are quasi-riskless during the 6 to 24 month deal seeking phase but can offer upside convexity. Though they can face mark to market volatility, if they are bought at NAV or a discount there should be no losses upon redemption. We are not aware of any incidences of fraud, and one case of a small paper loss was made up by a sponsor promote. There is compensation with additions if redemption is delayed. This fits in well with our firm philosophy of capital preservation,” explains Keller.
Return targets are moderate but can surprise markedly on the positive side: “We have a very conservative base case of 5% IRR, though it has been much higher on some deals bought during dislocations resulting in a couple of exits in the 50% up to 100%+ annualized range. So far, we only selectively bought SPACs with the intention to redeem and generated IRRs as high as 7% annualised over one month with two SPACs. Studies showing an average return of 12% for selling or redeeming shares with an unlevered strategy seem too high,” he points out.
Europe has half of the world’s largest family businesses, and they could make EUR 250-300 billion of divestitures. This democratizes access to private equity.
Leonard Keller, Portfolio Manager, Bantleon
There is a huge universe of more than 500 (mainly US) SPACs, of which over 400 are seeking a target. Bantleon pick their names based on quantitative and qualitative criteria: “We typically only invest below NAV, or at NAV when we participate in an IPO and get warrants in addition to the shares, which then become quite crucial for the upside. Most of our SPAC book was built after the correction in May 2021. We also rule out SPACs below USD 100 million market capitalization and those with low liquidity,” says Keller. “Qualitatively, we look at the quality of the sponsor, their track record, access to pipelines of private targets, and potential synergies,” he adds. Offering documents also need to be reviewed: “We benchmark documentation on areas such as warrants, lockups, and sponsor promotes, comparing a checklist against other SPACs”. And managers need to be interviewed: “When meeting SPAC management, we can compare their responses with over 150 SPAC investor calls we participated in,” says Keller, who has worked on De-SPACings.
Portfolio construction and diversification are also relevant in building the SPAC book: “We also seek diversification by geography, sector and envisaged company maturity such as pre- or post-revenue. Currently, we want to limit our exposure to SPACs seeking pre-revenue technology companies. We also want to be diversified by SPACs’ own stage – we try to avoid them all announcing deals at the same time,” says Keller. “This is similar to how a fund of fund would invest into private equity on a deal-by-deal basis, buying cash boxes.”
The asset class has been around for over 30 years but in 2020 a confluence of factors makes the space especially interesting: “Now that more high-quality sponsors are getting involved, we have the opportunity to co-invest with leading investors such as KKR, Khosla, Pershing Square, and other big private equity and venture capital houses while having a redemption option. There is also a wider universe of more mature private targets since companies are staying private for longer and can benefit from sponsors with public market experience. There are also more unicorns and family businesses making divestments: Europe has half of the world’s largest family businesses, and they could make EUR 250-300 billion of divestitures. This democratizes access to private equity,” Keller argues.
Investors need to access IPOs or take advantage of sell-offs to acquire large positions at a good price and the exit strategy also needs to be handled carefully: “In Europe it is possible to buy SPACs at a 3-5% discount but it is hard to build a big stake without the right access to liquidity. The next crisis could lead to forced sellers. The SPAC and its warrants can trade separately. We generally exit when or before they de-SPAC, but in some cases they might migrate to another fund or account that could continue holding them. We would tend to exit the SPAC and warrants at the same time because we do not want to be holding a hard to value asset. If we had to redeem without a premium, we might keep the warrants but would not want to be managing large numbers of small warrant positions,” explains Keller.
Special situations for Bantleon involve a deep fundamental dive from both a valuation and catalyst perspective. “Naturally, these positions have softer events and more beta than the other strategies in our portfolio so depending on market circumstances, may be hedged by a basket, option strategies, generic index overlays or combinations thereof,” says Scharping. This bucket requires an idiosyncratic “stock-pickers’ market” that rewards fundamental research, and so Scharping gets uncomfortable with this type of exposure if the economic strategists at Bantleon feel that markets are beginning to be driven by manias or macroeconomic factors, indiscriminately increasing correlations among stocks.
Bantleon’s special situations bucket includes value with a catalyst, and activism, which has also been related to mergers, or to spin-offs and corporate events in the relative value book, in about two thirds of cases. Bantleon’s shadow activism involves doing its own research on campaigns spearheaded by other activists, but generally refraining from joining activist groups or wolf packs to stay liquid and unrestricted. “Shadow activist positions have included Rocket Internet, where Elliott is co-activist, Orange Belgium, where we oppose the bid of mother company Orange and back Polygon’s proposal, and Aryzta where Veraison (and again Elliott) were both leading campaigns,” says Scharping.
Rocket Internet was a good example of the ‘G’ in ESG for its poor governance. The ‘E’ in ESG investing is creating a new class of opportunity partly due to forced sellers of companies such as fossil fuel producers. Bantleon started buying German utility RWE in mid-2019 partly based on its transition into renewables. The stock nearly doubled from the low 20s to high 30s and Bantleon has taken some profits but also sees potential for the exit from coal to be accelerated, if the Green Party joins Germany’s government. Market chatter even considers RWE as a possible bid target. Other investments with an ESG theme included Anglo American spinning off its coal unit, Thungela. French utility EDF, which is shunned by some ESG investors due to its nuclear exposure, is also followed.
There is a large universe of more than 500 (mainly US) SPACs, of which over 400 are seeking a target
Stubs, holding company trades and spinoffs are another stock-in-trade for Bantleon. Scharping appreciates that “sum of the parts valuation anomalies have been well documented by academics for decades, but they may persist longer than expected partly because passive, index tracking and benchmark-conscious investors do not pay enough attention to them until highlighted for example by activist investors”.
The relative value book might be an average of 10-30% of NAV through the cycle, but it was reduced significantly in March 2021, partly because retail investor activity in “meme” stocks can also upset the short leg of relative value trades. “One example was Volkswagen’s less liquid share class – the ordinaries linked to the ADRs – which rallied strongly after they became a play on the electric vehicle theme. We are evaluating solutions such as hedging with sector peers, or custom baskets, but we expect the retail investor frenzy could continue,” says Scharping. In any case, the bar is always quite high for entering a relative value trade: “We need to see significant valuation discrepancies of typically at least 10% gross, which we do not see often now with markets at all-time highs. The relative value book is competing for capital with the merger arbitrage and SPAC books. We also need to identify a discrete catalyst because mean reversion is not enough”.
The book has been bigger when the opportunities were more attractive, as was the case around the Covid crash. “In March 2020, we moved into the Christian Dior/LVMH situation after the spread widened from a usual 10% to 30%. We could see catalysts as the Arnault family planned to streamline its holding companies and might take Christian Dior completely private. Also in mid-2020, we bought into Italian infrastructure group, Atlantia. The catalyst here was its sale of a toll road business that had been responsible for the Genoa bridge collapse. We also saw recovery potential on the Rome airport and Eurotunnel assets as vaccinations gathered momentum, and potential for restructuring. We bought monopoly assets on a 10% FCF yield and potential to pass through inflation, and therefore hedged only lightly,” says Scharping.
In June 2021 opportunities were more selective or intermittent. “Situations are monitored for attractive entry points when catalysts are seen but we would not buy and hold these trades because markets can stay irrational longer than we can stay liquid,” says Scharping.
In share classes, “the non-voting preference shares of Grifols trade at a 35% discount to the ordinary voting shares, which is one of the widest spreads. The catalyst here could be the Spanish Council of Ministers’ proposal for double voting rights in Spanish companies, which would let Grifols convert its preferred into ordinary shares. There are precedents of similar changes in Italy,” says Scharping.
In holding companies, some trades can be three legged: “The Naspers/Prosus/Tencent trade offers relatively high holding company discounts. This is a pyramid with three levels always connected and we always triangulate it for the three companies. We will put on the trade if we see catalysts for reducing the Naspers to Prosus, or Prosus to Tencent, discounts. This could be China-related news for the Tencent spread,” says Scharping. “European conglomerate trades that we always monitor include Exor, which among others has stakes in Stellantis, Ferrari, CNH, Juventus Turin, and a private reinsurance business, Partner Re, that is hard to value. Catalysts are less visible currently but could include buybacks or maybe even an activist investor pointing out the discount and pushing for structural change”.
Interconnections between the buckets help to structure the portfolio. Vivendi is an example of a trade that has straddled several sub-strategies. “It started as a sum of the parts special situation, in March 2020, when UMG made up more than 70% of the valuation. It then planned to sell a stake to a SPAC, Pershing Square Tontine Holdings, which we also own,” says Scharping.
Bantleon’s allocations between the strategies are partly informed by a top-down macro view from the firm’s award-winning economists. “They currently expect inflation to be more persistent than the consensus transitory view, and are overall still constructive on the economic outlook, deal activity and CEO confidence. This view also influences the extent to which softer catalyst special situations trades are hedged. This underscores the high-risk arbitrage weighting, but some balance is maintained for diversification. The correlations between the books are low. Relative value is inherently market neutral as are holding company and dual listing discounts. There is also usually no correlation between the merger arbitrage and SPAC arbitrage strategies. The special situations sleeve may only contain ten or so holdings and cannot easily be compared to an index, but in normal market conditions it has a low correlation to the others. The trades in the special situations book should normally be idiosyncratic, but the amount of equity beta does vary with how much is hedged,” says Scharping.
Across the books, correlations within merger arbitrage should normally be low as concentrations of specific deal risks such as US or Chinese antitrust exposure are monitored closely. Within relative value they should also normally be low since there is no reason for example for the BMW share class spread or the Porsche/VW spread to be correlated. Style and factor risks are also monitored. “We have a dedicated quant lab who decompose our soft catalyst portfolio into all the typical factors at any given time. We take this input and then decide what factors, such as degree of growth or small cap exposure, we are comfortable with and which we want to hedge out via custom baskets, or indices,” says Scharping.
The need for new and more diversified return streams might soon become more urgent. “A dynamic event driven strategy such as we provide is well suited to the next capital market phase, which will see lower equity market returns, more volatility, new correlation patterns and that will be hostile for most fixed income strategies,” Finke says.
Scharping expects 2021 to become another record year in terms of event activity. A record number of deals has already been announced so far this year, and he continues to see opportunities not only within the M&A space but also across other catalyst-driven sub-strategies: “The combination of the phenomenal recent pick-up in deal activity, the convexity of our SPAC book and growing evidence of a post-Covid business recovery, lead us to believe that the next few quarters will most likely be the most exciting for opportunistic event-driven investing since we established our team at Bantleon more than 3 years ago”.