DIANE HARRISON In an Event-Driven World, is Secular the New Profane?

This article appeared online on May 1, 2013

IN AN EVENT-DRIVEN WORLD, IS SECULAR THE NEW PROFANE?

Half of the secular unrest and dismal, profane sadness of modern society comes from the vain ideas that every man is bound to be a critic for life. Henry Van Dyke, 1852-1933 The investment universe of core and satellite holdings is undergoing a seismic shift. It used to be that a concerted study of market behavior, historical price movements, and diligent corporate research would yield an investment manager solid footing on which to base an investment thesis. In market-speak secular refers to a market driven by forces that could remain in place for years, causing the price of a particular investment or asset class to rise or fall over a long period of time. Top-down or bottom-up, analysts would apply a practiced eye to assessing these elements in determining market direction at both the macro and micro level. Managers who took a less-traditional path to form an investment viewpoint, through evaluation of specific market triggers or catalysts, were seen as slightly outr, out on the fringe of the analytical investment establishment. One might also have referred to them as somewhat profane, or blasphemous. Flash forward to 2013 and the event-driven, opportunistic investment managers have taken center stage. Its a bits and bytes world, where react ion times have compressed across all market sectors, and nimble players are in hot demand to deliver results from a myriad of market catalysts. One of the bellwether indicators of this shorter-term trading trend is the CBOE Volatility Index (VIX), a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. The CBOE website provides this explanation of the index as an indicator of investor risk-on, risk-off behavior: Since its introduction in 1993, VIX has been considered by many to be the world's premier barometer of investor sentiment and market volatility. During periods of financial stress, which are often accompanied by steep market declines, option prices - and VIX - tend to rise. The greater the fear, the higher the VIX level. As investor fear subsides, option prices tend to decline, which in turn causes VIX to decline. In April Hedgeweek reported that, in VIX futures trading, total volume for the first quarter of 2013 was a record 9,181,060 contracts, surpassing the previous high of 7,613,774 total contracts during the fourth quarter of 2012 by 21 per cent and up 123 per cent from the 4,111,148 contracts traded during the first quarter of 2012. Clearly demand is
PANEGYRIC MARKETING| MAY 2013

DIANE HARRISON In an Event-Driven World, is Secular the New Profane?

growing for managers with an ability to capitalize on the price sensitivity of the global markets. Lets take a look at why an investment deficit disorder, or IDD, mentality can pay off for some managers. A number of current market opportunities provide a target-rich environment for the fast thinker and intuitive decisionmaker. While the broader market experienced a robust performance during the first quarter of 2013, Evestment reported its HFN Event Driven Index also to be up just over 4%. This index includes funds that take positions in securities with the expectation of specific events that may positively impact the valuation of their positions, such as acquisitions, reorganizations, spin-offs, debt exchanges and litigations. A few of the areas in which these managers can succeed include: Short-Term Quants Black-box specialists, often formerly viewed in a suspicious and doubtful manner, have become attractive to investors as a means of exploiting the market volatility and price disruptions caused by a variety of economic and other factors. Systematic trading strategies that can identify and act upon mean reversion price moves and arbitrage opportunities across a range of sectors allow non-technical investors to participate in market volatility as a means of reducing their exposure to the risks inherent in the markets overall. Quantitative managers with both attractive performance and the ability to define and describe their trading methodology are growing in popularity with all segments of the investor spectrum. Its important to note that those quants who fail to articulate their methodology do not enjoy the same level of interest from investors, who want to understand what it is they are investing in before making the leap into any black-box strategy. Special Situations Companies undergoing some form of value driver might include corporate reorganizations, spinoffs, new issues, stock buybacks, or bankruptcy. Searching and sourcing tools, such as the subscriber-based Gemfinder.com, collect SEC and other government filings in a centralized process and provide them online, helping managers to distinguish the meaningful from the mostly trivial corporate news. Managers who are able to analyze and act upon such data can position themselves to extract alpha from corporate action before the news is widely distributed or publicly known. Active Microcap The bottom 20% of the corporate capitalization ladder is ripe with investment opportunities. The companies represented are usually early-stage and small, with lean operating budgets, and a management team generally heavily invested in the success of its growth, typically with a narrow business focus in an area in which the management believes itself to have some critical level of expertise. This segment of the cap space is also more volatile than its larger brethren, but the excess returns that can be generated within it make it attractive for investors able to tolerate the larger performance spikes.

PANEGYRIC MARKETING| MAY 2013

DIANE HARRISON In an Event-Driven World, is Secular the New Profane?

Distressed Credit For years, the credit challenges facing companies across all sectors has created fertile ground for event-driven and catalyst investors. Despite the repeated QE actions and fiscal policy support of governments in the U.S. and abroad, credit anomalies and dislocations continue to provide opportunities for managers familiar with analyzing this market activity. In general, the arbitrage opportunities presented by companies emerging from bankruptcy into a more stable entity can lead to significant upside for their bonds, which would have traded substantially below par during the firms crisis. Managers can work this particular investment angle through purchasing pools of distressed debt via mutual funds, which are not allowed to hold securities that have defaulted, or by investing directly in singular entities, betting on the turn-around of a potential target through a lending arrangement.

A further advantage for the nimble investment opportunist is that these managers can be market agnostic in terms of price direction. Mean-reversion and arbitrage strategies seek to profit from prices returning to their normalized range from points either higher or lower than these levels. Event-driven investing tends to work best when the economy is strong, because corporate activity is highest in terms of growth or expansion, while distressed investing tends to be more rewarding when the economy is performing poorly, as greater numbers of companies find themselves in default or bankruptcy. Bulls and bears can find opportunities when the markets move regardless of direction. With investors seeking greater range in portfolio diversification, managers skilled at exploiting whatever curveballs the markets see fit to throw can showcase their particular strategy. All this is not to say that investors are abandoning the traditional value and growth strategies in their investment objectives. Rather, investors are learning to embrace change, uncertainty, and flexibility as additional means of defensively positioning themselves for the long term. What has become clear to everyone over the past decade is that no single strategy will provide the best answer to todays market mysteries. While its rarely clear where the markets will take us on their journey, investors who recognize the value of having diversified approaches will ultimately be positioned for greater success over the long term. When you're finished changing, you're finished. Benjamin Franklin, 1706-1790

Diane Harrison is principal and owner of Panegyric Marketing, a strategic marketing communications firm founded in 2002 and specializing in a wide range of writing services within the alternative assets sector. She has over 20 y ears of expertise in hedge fund marketing, investor relations, sales collateral, and a variety of thought leadership deliverables. A published author and speaker, Ms. Harrisons work has appeared in many industry publications, both in print and on -line. Contact: dharrison@panegyricmarketing.com or visit www.panegyricmarketing.com.

PANEGYRIC MARKETING| MAY 2013