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Manager Commentary – April 2, 2018

Following a year of historically low volatility, the market exhibited demonstrably higher uncertainty in the first quarter of 2018. The CBOE Volatility Index (“VIX”), a popular measure of domestic equity market volatility, rose from 10 at year-end to a peak of 37 in early February. Since February, VIX levels have continued to fluctuate between 15 and 25. This volatility reflects the recalibration of market valuations with respect to the removal of the Federal Reserve’s quantitative easing policies, higher short-term interest rates, steady economic growth, and higher potential inflation.

Increases in Treasury yields have not led to significant increases in credit spreads, which continue to be near the tights seen in mid-2014. Most bond price pressure has instead been driven by interest rates. Lower medium grade bonds and non-investment grade speculative bonds have seen the biggest increase in credit spreads during this most recent move up in Treasury yields, reflective of lower appetite for bonds with more rate sensitivity.

The event-driven landscape was not immune to the effects of the quarter’s volatility spikes. While continued economic growth and recent changes to the US tax code have led to more investment opportunities in mergers and acquisitions, assets sales, and spin-offs, there are currently five deals that are primarily responsible for driving returns and volatility in the merger arbitrage space:

  • Qualcomm for NXP Semiconductors (QCOM/NXPI)
  • Microchip Technology for Microsemi (MCHP/MSCC)
  • United Technologies for Rockwell Collins (UTX/COL)
  • AT&T for Time Warner (ATT/TWX)
  • Bayer AG for Monsanto (BAYN GR/MON)

The major factor impacting QCOM/NXPI, MCHP/MSCC, and UTX/COL is the trade dispute between the US and China. Headlines, tariffs, and possible trade negotiations between the two countries have led to stricter scrutiny and delays in the CFIUS (Committee on Foreign Investment in the United States) and MOFCOM (Ministry of Commerce of the People’s Republic of China) approval processes required for these deals to conclude. The outcomes of ATT/TWX and BAYN GR/MON, on the other hand, are being governed by US antitrust approval processes.

We continue to believe that the resolution of these deals will influence spreads, performance, and volatility in the near-to-medium term, and we look forward to providing our insights as these events evolve.

The CBOE Volatility Index (“VIX”) is an index that is commonly used as a measure of domestic equity market volatility. A credit spread is the difference in yield between a US Treasury bond and a debt security that are identical in all respects except credit quality. A Treasury yield is the return on investment of a US government debt obligation. Quantitative easing is a monetary policy whereby a central bank buys predetermined amounts of government bonds or other financial assets in order to stimulate the economy and increase liquidity.

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