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Manager Commentary – February 28, 2018

Interest rates have been a focal point of conversations this past week. Regarding the impact to the overall equity and credit markets, here are our thoughts:

  • The market is undergoing a crucial period where Central Banks are removing quantitative easing from the system, while deficit spending is expected to increase longer-dated treasury issuance. Although economic growth indicators continue to show positive momentum, interest rates are recalibrating higher with expectations that growth will lead to higher inflation.
  • The US 10-Year Treasury yield increased from 2.41% at year-end to 2.90% last week. The move was a significant contributor to the market volatility seen over the prior month.
  • Further contributing to the rates discussion, minutes of the Federal Open Market Committee’s January meeting were released last week. The notes indicated a more positive view on the growth outlook citing recent tax legislation, the global economic outlook, and easier financial conditions as supportive of growth “over coming quarters.” Despite this upbeat assessment, committee members did not yet see strong signs of wage pressure.
  • During the market’s recent volatility, credit markets appeared more driven by rate fears rather than credit concerns, but credit trading has been orderly. We think that future volatility in fixed income markets will come more from the velocity of rates changes rather than actual higher levels.
  • Primary issuance activity remains on track and we would expect to see continued demand for levered loans as the product provides floating rates and a hedge against rising rates. (Loans are also a key component to deal financing.)

Beyond the broader markets, the rate conversation is also affecting the event-driven space. Our recent observations:

  • Event-driven strategies have held up relatively well during the recent market volatility and provided a buffer to investor equity and fixed income portfolios.
  • We continue to see investor interest in strategies that are less impacted by rising interest rates and high volatility.
  • During the most volatile market period, merger arbitrage spreads widened, primarily in transactions with longer-dated timelines.
  • In equity special situations, event premiums remained relatively stable. Long re-ratings that were paired with market hedges traded flat to slightly better as the alpha long positions outperformed the market. (Conversely, short re-rating positions did the opposite as long market hedges underperformed alpha shorts.)
  • Wider spreads and lower prices provided the investment team with favorable opportunities to add to specific equity and credit positions.
  • Several recent deal announcements highlight continued activity in the mergers and acquisitions space (e.g., Qualcomm raised its offer for NXPI from $110 to $127.50 per shares; Rite Aid entered into a merger agreement with privately-held Albertsons for the remainder of its stores that are not being sold to Walgreens; and Comcast proposed an all-cash offer to acquire Sky, placing it in direct bidding competition with a pending offer from 21st Century Fox).

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. An alpha security, or alpha position, refers to the primary security of an investment idea (i.e., excluding hedges). A re-rating occurs when the market changes its view of a company sufficiently to make valuation ratios (such as price-earnings ratio) substantially higher or lower. The US 10-Year Treasury yield is the return on investment on US government debt obligations with a maturity of ten years, the amount and direction of which is a commonly-used economic indicator.

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