Should you join the new 'deal frenzy'?
Julian Knight on the funds best set up to benefit after a heady day for mergers and acquisitions
Saturday 18 January 2014
Six bids, one day. It was like the 1980s and the fictional Wall Street world of Gordon Gekko all over again. Multibillion-pound offers for some of the planet's biggest companies last Monday could potentially have marked the start of a fresh bull run for stock markets in the developed world.
Tom Stevenson, from the fund management group Fidelity, said: "Six bids in one day is a pretty good indication that company managements have regained the confidence to go out looking for opportunities to grow their business."
No wonder the front page of the free Square Mile newspaper City AM screamed "Deal Frenzy" as a result. But how can you as a private investor, with long-term objectives in mind, benefit from what could be a revival in big deals in corporate Britain, America and other parts of the globe?
In some ways it is best to take it quite easy – just invest over time with steady fund managers and enjoy the almost inevitable uplift in general stock market values that comes from a fresh round of mergers and acquisitions.
Investing smallish amounts over a long period will also help you smooth out the peaks and toughs of investment performance as that approach takes market timing out of the equation.
But there is another course of action, which is to look at fund managers that are quick on their feet, have a proven track record and also a free enough hand to make the most of any "deal frenzy".
According to Jason Hollands of the financial adviser Bestinvest, such speed of reaction is normally the preserve of hedge funds – out of the reach of all but a handful of investors. But there are ways to gain access to this universe, he said. "There used to be a UK-listed fund of hedge funds with an event- driven mandate, but it got wound up a few years ago. The nearest option I can think of would be to invest in London-listed Alternative Investment Strategies, an investment company which invests in a portfolio of hedge funds."
Another alternative is to look at funds that invest in a sector being tipped for major merger and acquisition activity. "We think M&A might be a feature in particular sectors, such as the small-cap end of the tech space," said Mr Hollands. "Bigger US tech names currently have strong overseas cash balances that are earning little in the way of interest and which would be subject to a higher rate of tax if repatriated.
"A fund that might therefore benefit from such activity would be Herald Investment Trust, which invests in smaller tech companies, primarily in the UK.
"Another area that might excite some interest is retail, given the news that Sports Direct has taken a stake in Debenhams.
"For example, AXA Framlington UK Mid Cap has a top 10 holding in Sports Direct, which has previously gobbled up parts of former rival JJB Sports," Mr Hollands added.
Because of the structure of most investment funds – a large number of shares held to spread risk – a manager getting a bet right on a merger or acquisition may not affect the overall return to investors by much. It may increase the kudos of the manager among his or her peers but generally it will be barely registered by most investors.
Nevertheless, as Patrick Connolly at the adviser AWD Chase de Vere explained, it is still worth looking at managers who buy a basket of shares in a merger and acquisition hotspot.
"While fund managers don't tend to actively target stocks which they feel could be ripe for a merger or takeover, those managers who look for good-value mid and small-cap stocks can, almost by default, benefit from increased merger and takeover activity," Mr Connolly said.
Funds that he likes, and thinks are well placed, include Rathbone Income, M& G Recovery and BlackRock UK Special Situations. The last of these, managed by Richard Plackett, "places a big emphasis on investing in small and mid-sized companies as the fund manager believes they will grow faster than their larger counterparts," said Mr Connolly. "It typically holds more than 50 per cent of the fund in these companies, focusing on good quality, and while the manager doesn't buy them for their takeover prospects, he readily admits that increased activity is likely to be beneficial for his fund."
As for when the "deal frenzy" will occur, Darius McDermott at Chelsea Financial Services thinks we won't have to wait too long. "One manager I spoke to said he thinks companies thinking of purchases will look to do deals sooner rather than later now as [the tapering in quantitative easing in the US] means cheap money could come to an end earlier than imagined. Perhaps this is the case or businesses are simply more confident of the outlook and willing to spend some cash rather than sit on it. There is certainly a lot of spare cash on balance sheets right now, so the trend could continue."
Mr McDermott believes that the funds in poll position to take advantage of this include Franklin UK Mid Cap and Marlborough Special Situations. "Both run by very experienced managers with good track records," he said.
Like Mr Connolly, the M&G Recovery fund, managed by Tom Dobell, impresses Mr McDermott.
However, investors should take note of a fund's size as this can often dictate the speed with which a manager can adapt to new opportunities. "The fund needs to be small enough that its own investment process isn't compromised by either having to move up the cap scale or simply having too small positions in too many stocks that none really have an impact," said Mr McDermott.
All in all, though, few managers buy a stock based purely on its takeover potential. The thought may lurk at the back of their minds, but those who look to hop from investment to investment tend to have short but interesting times in their posts.
Ultimately, nearly all fund managers have a benchmark to beat, and if they fail to do so, they may be out of a job. Making big bets on takeovers is one way to outperform a benchmark, but it is a high-risk approach and outside the remit of many managers.
However, as Brian Dennehy, managing director of Fundsnetwork pointed out, sometimes the approach of a particular fund makes it much more likely that it will be a beneficiary when mergers and acquisitions take place.
He said: "I don't know any manager who buys stocks for takeover potential per se. They will, though, try and pick up some companies on value criteria – and if they get that right, takeover potential is baked in as a possibility."
But if investors try and go it alone and second-guess a likely takeover, they are likely to find that it is already factored into the share price.
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