The Blindside of Moneyball Vertex Arbitrage Fund Plus
Michael Lewis is a legendary financial journalist, but he has also written many non-financial books. In The Blind Side: Evolution of a Game (you know, that Sandra Bullock movie), he wrote about how football evolved to have specialty players to protect the quarterback’s vulnerable “blind side” as he throws. In merger arbitrage we also talk about the “blind side” of having a surprise event derail the progress of a deal – these are unknown unknowns, as opposed to the risks we identify upfront. Thus, we talk about a deal having upside, downside, and the blind side during our investment assessment.
Recently, a deal for Fresenius to acquire Akorn (a generic pharmaceutical company), has been rattled by a blind side event: an anonymous tipster has alleged that the company is guilty of FDA data integrity violations. The stock traded from a price of $30 down to $17.50 based on this issue. Not good if you’re long the deal.
However, there were a number of red flags (see WSJ subscriber article) we previously identified, that made us nervous about the deal: weakening fundamentals, an overly long process to negotiate antitrust divestitures, and a management team with a controversial history. Ultimately, the relatively small upside given the many issues led us to take a short position in the stock last summer. Our patience was tested prior to this news, as our short was mildly profitable and the deal was approaching possible closure, which would have put the position at a loss. Ultimately, waiting paid off in a large way and we have covered over half of our short position at substantial profits.
Our point is not schadenfreude, but to point out that although we usually own the target (long) side in a merger, we are also able to profit from taking short positions when warranted and that it is judgment and experience that helps us separate the wheat from the chaff.
Below is a screen grab of Akorn’s 1-year chart (white line being the stock price).
A Penny Not Lost is a Penny Earned
February saw volatility return to the markets in a hurry and provided a showcase for the durability of the fund’s merger arbitrage strategy to weather, and importantly, still make a profit during a storm. This brings us back to Michael Lewis and his other non-financial book turned movie, Moneyball: the Art of Winning an Unfair Game (you know, the Brad Pitt one) which looked at the 2002 Oakland Athletics use of player statistics like on-base percentage and slugging percentage as indicators of offensive success, instead of traditional speed and contact. We often view our investment approach as if we’re swinging for singles or doubles. Although we miss out on the home run glory, one can’t score while riding the pine. Thus, we strike-out significantly less, and by doing so, avoid the ill-timed cold streaks that tend to happen when your team really needs a run. Every team (like a portfolio) needs their big hitters, but nobody stays competitive without also having consistent, everyday producers to rely on.
Below is a cumulative, daily performance comparison of the fund versus the Canadian (TSX) and American (S&P 500) stock markets, from February 1st to March 2nd.
Vertex Arbitrage Fund Plus daily returns are from an internal portfolio management system and are unaudited.
As a reminder, the fund’s primary source of return is tax efficient, capital gains, not income.
Have a great weekend!
Vertex Arbitrage Fund Plus Fact Sheet
Vertex Arbitrage Fund Fact Sheet
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