Investing in the shadow of bear markets
Investing Journey bought Shaw Communications to bet on Rogers Communication’s takeover bid going through. Shaw’s stock price is currently trading at a discount to the price offered by Rogers and will deliver a gain of nearly 14% when the deal closes. Given the bid could take 3 to 6 months to finalize, the annualized gain will range between 28% to 56% .
The merger proposal meets the top 2 criteria for successful completion. First, it is a friendly offer, favoured by executives (and controlling families) of both companies. Second, due to the regional and separate nature of their markets, the increase in market control would not seem to be big enough for regulators to reject the bid.
The nice thing about merger arbitrage: it is the investment approach that academic studies have found generates the best Sharpe Ratio, that is, the best returns relative to price volatility (in other words, best risk-adjusted returns).
Even better are the absolute returns. They depend just on the deal closing, not macro or market variables. If the economy or market tanks in the next 3 to 6 months, this position should provide a positive return to help keep the overall portfolio afloat.
When investing legend Warren Buffett was running his investment partnerships from 1957 to 1968, he never had a loss in a year even though the Dow indexes were down in four of the years. Merger arbitrage is what allowed him to deliver positive returns in both bull and bear markets. As he wrote in a 1964 letter to investment partners:”
“The predictability [of merger arbitrage] coupled with a short holding period produces quite decent annual rates of return. This category produces more steady absolute profits … than [undervalued stocks] do. In years of market decline, it piles up a big edge for us.”