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23 November 2022

Commentary

It has been a grueling year for investors so far – globally, and in Asia. The war in the Ukraine, the geopolitical tensions between China and the U.S., the high inflation prompting central banks to raise rates to levels not seen in twenty years, the QE of the past years turning into quantitative tightening this year, the inverted yield curve in the U.S. auguring a recession – all this contributed to the collapse of both bond and stock markets. And investors allocating to assets in Asia were not spared the rout.

Still, there are bright spots. Investing in activist hedge funds made for a relative outperformance versus other hedge fund strategies since the beginning of the year and also versus investing in stocks and bonds in the region. On a longer time horizon (since the beginning of last year), activism in Asia not only outperformed other strategies, but also yielded a positive return in absolute terms – something you don’t find often in the current environment.

The Eurekahedge Event-Driven Index, which measures the performance of merger-arbitrage funds and activist hedge funds, has lost 7 percent since the beginning of the year (see chart). That’s still 5 percentage points better than the 13 percent decline of the Eurekahedge Asia Hedge Fund Index (which represents the whole of Asia’s hedge fund industry), almost 9 percentage points better than the Bloomberg Asia USD Investment Grade Bond Index and a whopping 27 percentage points better than the MSCIA Asia ex Japan Equity Index (all returns are in USD).

Not a bad year so far for activist funds. Still, since the beginning of last year, they are doing well not only in relative, but also in absolute terms. The Eurekahedge Asia Event-Driven Index is up almost 7 percent since beginning of 2021. During the same time, the Eurekahedge Asia Hedge Fund Index has lost 7 percent, the Bloomberg Asia bond index almost 16 percent, and the MSCI Asia ex Japan a (whopping again) 38 percent.

By the way, the same picture emerges when you look at longer time horizons over the past ten years. With one exception, the event-driven strategy outperforms the investment in the broad Asia hedge fund sector as well as in Asia stocks or bonds.

It seems that activist investors’ ability to generate alpha makes the difference. Broad markets cannot escape macroeconomic factors such as domestic and foreign consumption and interest rates. They are also driven by how deep the “liquidity punch bowl” is which central banks serve them. Lower interest rates make for higher liquidity and a deeper punch bowl.

The target companies of activist investors are also driven by those “market”- factors, but to a much smaller extent. They are more impacted by the specific factors of the respective campaign such as promoting strategic or operational change or having an M&A component, and that largely “immunizes” them against broader market movements. Stocks of a target company jump if the activist investors successfully argue for better merger terms, even if the market is down.

As an example, shares in Japanese venture-capital company JAFCO Group surged as much as 16% on August 16, the most in six years, after disclosing that parties linked to activist investor Yoshiaki Murakami have shown interest in acquiring a 51 percent stake. The benchmark Topix index lost 0.15 percent the same day.

In Korea, K-pop giant SM Entertainment jumped as much as 13% on October 14 after the company said it will end a contract with Like Production ahead of schedule after activist investors called for a review of the contract. The investors said that SM Entertainment has paid hundreds of millions of dollars every year to Like in royalties, which would undermine SM’s shareholder value.

No stock is fully immune against market movements. And activist investors, cannot fully escape the market rout. But by picking the right stocks and choosing their fights wisely, activist investors’ returns provide a cushion against the once- in-a decade market collapse. And investing in activist hedge funds helps investors diversify their portfolios.