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Over the past few trading days we have witnessed a spike in volatility that caught many market watchers off guard, with the CBOE Market Volatility Index, aka the “VIX,” having closed above 20 for the first time since November 2016. The market sell-off was largely a reaction to fears of rising inflation and the potential for interest rates to rise more quickly than expected, and it has caused some investors to review their portfolios and reset their near-term expectations for global equity markets.

We at Water Island Capital are always cognizant of the volatility environment. Volatility can be one of the drivers of returns for event-driven investment strategies, and we believe that for a prudent and prepared investor, bouts of volatility can serve more as opportunity than as misfortune. With that said, how has this recent shake-up in the market impacted our strategies, and how are we reacting?

  • Large scale market movements have resulted in derisking by market participants across the board. This has led to wider spreads in certain transactions and better profit opportunities across event-driven strategies, most specifically merger arbitrage.
  • Entering 2018 our expectations for renewed volatility and a market pullback drove our decision to maintain above-average cash levels. This “dry powder” has allowed us to take advantage of opportunities across the event landscape. We’ve added capital to our highest conviction ideas at attractive entry points, effectively enhancing the portfolios’ potential return profile.
  • In our merger arbitrage strategy, there have been some mark-to-market impacts to specific deals as spreads have widened, but we believe that these will be among the first to recover given the definitive contracts that are in place.
  • Importantly, our sizing and positioning procedures during volatile periods follow the exact same processes utilized during normalized market conditions: we continue to focus on high conviction, strategic, definitive situations.
  • In managing our portfolios, we attempt to reduce or eliminate short-volatility exposure, with the goal of generating a market neutral stance that can endure the types of conditions that we’ve witnessed over the past few days.


In our communications with clients, we have consistently emphasized how interest rates and volatility can drive returns for spread-based strategies such as merger arbitrage. Given the recent trends in these areas, we believe the marketplace is moving in a direction that can prove beneficial for our event-driven strategies and, ultimately, our clients.

Spreads, or deal spreads, refers to the difference between the price at which a target company’s shares currently trade, and the price an acquiring company has agreed to pay. Mark-to-market refers to the valuation of investments based on current market values. To derisk means to take steps to make something less risky or less likely to involve a financial loss, and frequently involves exiting or reducing positions. The CBOE Market Volatility Index, or VIX, is an index that is commonly used as a measure of domestic equity market volatility.