Candriam Team’s 14 Years of Merger Arbitrage UCITS

Gauging ESG and deal break risks

Hamlin Lovell

Fabienne Cretin and Stéphane Dieudonné moved from OFI Asset Management to Candriam along with their merger arbitrage strategy and UCITS fund in 2018. Candriam is the third corporate parent for the duo, who have worked together since 2004, and were at ADI Alternative Strategies before OFI. France ranks as the fourth largest centre for hedge fund assets under management in Europe, according to Preqin’s 2017 survey. Fabienne was lured to Candriam partly because she expects to benefit from various aspects of its platform.

Candriam, which is managing EUR 121 billion as of September 2018, operates autonomously as part of New York Life Investment Management (NYLIM). It has been running alternative UCITS strategies since the 1990s. Candriam’s alternatives single strategy range includes: long/short credit; long/short equity; equity market neutral; index arbitrage; quantitative equities; managed futures; global macro; unconstrained asset allocation; convertible bonds; corporate credit; unconstrained bonds, and the merger arbitrage strategy, which is called “risk arbitrage”.

Fabienne is exploiting positive synergies with other teams at Candriam, including its credit team, who manage strategies that have received The Hedge Fund Journal’s ‘UCITS Hedge’ awards. “We sit right next to the credit desk, who run over EUR 7 billion in high yield, and often finance some of the merger deals we are invested in,” she says. “They keep us informed about whether deal financings have closed, and could give us an early warning signal of problems in the credit markets.” As of November 2018, credit spreads have widened, as have deal spreads on LBO and MBO mergers, but Fabienne has not noticed any deals failing due to being unable to get away financing, and is still, selectively, invested in some deals that involve financing. 

Candriam’s fundamental equity teams – both on the traditional and the long/short side – can also be helpful. For instance, the digital long/short technology fund has been active in a Dutch technology company [Gemalto] that is being bid for by a French company, so the two teams have compared notes on antitrust issues. The merger arbitrage duo have also had a long discussion with the tech team about a substantial bid for an open source technology provider [Red Hat]. 

Candriam’s equity dealing and financing desk, which has many counterparty and prime broker relationships, also helps with trading, execution, sourcing stock borrow and equity swaps. These were functions that Fabienne and Dieudonné had to handle by themselves at previous firms. 

Candriam additionally carries out currency hedging, which is strictly applied to hedge portfolio exposures to the Euro denomination of the fund.

ESG

Candriam Risk Arbitrage is the first merger arbitrage fund to have explicitly told us that they are incorporating ESG factors. This is consistent with Candriam’s name – an acronym of Conviction And Responsibility In Asset Management (on the long-only side, Candriam has launched some ESG ETFs). Candriam has been an early mover in this area, pursuing sustainable and responsible investments for over 20 years.

Today, Candriam’s ESG policies rule out certain stocks altogether. Since 2009, the firm has been applying a controversial armament exclusion filter to all its assets under management. Any companies exposed to the weapons industry are permanently excluded if: they are involved in the manufacture or sale of anti-personnel mines, cluster bombs, or depleted uranium; or more than 3% of their revenues are generated from the manufacture or sale of conventional weapons. This year Candriam has introduced additional exclusions: companies with more than 10% exposure to thermal coal; any companies which add new thermal coal projects, and all companies with more than 5% exposure to tobacco. The firm’s ESG research can also measure the ‘G’ in ESG – and help the merger arbitrage team to appraise governance risks in deals.

Announced deals only

ESG apart, Candriam pursues a pure, “plain vanilla”, merger arbitrage strategy, trading only announced deals, with no pre-event trades, “rumour-trage”, or other corporate events, such as special situations, share class arbitrage or holding companies. The team did trade other event driven strategies before 2008 when at ADI, but ceased after analysis showed that losses in that year – their only losing year – were caused by the event-driven bucket. “We think an alternative fund should be more alpha and less beta,” says Fabienne, who featured in The Hedge Fund Journal’s 2018  “50 Leading Women in Hedge Funds” survey in association with EY. (Candriam’s Head of External Multi-management, Maia Ferrand, has also featured in another edition of this survey, and was interviewed by THFJ in issue 110).

The merger arbitrage sleeve of the ADI strategy generated a small profit in 2008, despite seeing over 10% of its deals break in a market environment where around 20% of US merger deals fell through. This fits in well with the profile of the firm’s alternative offering: some 55% of Candriam’s alternative strategies also profited in 2008 – and 64% did so in 2011.

All of Candriam’s single strategy alternatives funds – and the ADI merger arbitrage fund that Fabienne and Dieudonné were running at the time – remained liquid in 2008. Candriam’s daily dealing risk arbitrage UCITS IV fund currently contains close to EUR 400 million of assets. Fabienne envisages capacity of around EUR 1 billion for the strategy, and invests across mid-cap, large-cap and mega-cap merger deals, generally with a market capitalisation of at least EUR 300 million in Europe or USD 500 million in the US.

The risk arbitrage strategy is among a number of Candriam alternative strategies that are essentially targeting “cash-plus” returns through a full cycle, and are viewed as attractive bond substitutes, particularly given that interest rates remain negative in the Eurozone. Over the last five years, the strategy has generated a Sharpe ratio around 1.6, with low correlation to equities and bonds, and much smaller drawdowns than many other merger arbitrage funds. This smooth return pattern has come both from a deal break rate roughly half that of the global merger universe, and from portfolio construction. 

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