"We risk becoming the best informed society that has ever died of ignorance"
- Rubén Blades

"You can't make up anything anymore. The world itself is a satire. All you're doing is recording it"
- Art Buchwald

"It's getting exciting now, two and one-half. Think of everything we've accomplished, man. Out these windows, we will view the collapse of financial history. One step closer to economic equilibrium"
- Tyler Durden

"It is your corrupt we claim. It is your evil that will be sought by us. With every breath, we shall hunt them down."
- Boondock Saints

Tuesday, May 20, 2014

Recent M&A Activity And What It Means Re: FED Taper

Jason Raznick, the CEO of Benzinga has a Tumblr account that he recently started and his most recent post on M&A activity is worth reading.  The ramp in M&A and the increase in Covenant-Lite backing leveraged loan LBO's has enticed money away from traditional markets (big money went to Alt. Investments as equity risk premium pushed historic threshold and the appeal of low-rate fixed-income lost its luster). 

Via Tumblr:
Merger & Acquisition activity has been explosive since the great recession first hit in 2007/2008.  Aside from deals that were announced and cancelled, 2014 is on track to surpass the $1 trillion level in closed M&A deals.  It appears at first glance that buyers are scrambling to take advantage of cheap money before the FED raises rates.  A recurring phrase I’ve heard among our news desk analysts is “Covenant-Lite.”

Covenant-Lite loans are debt-issuance that have lesser restrictions on collateral, payment terms, and accreditation applied to income regarding worthiness of investors.  The C-L metric applies to private equity groups performing highly-levered buyouts and lends a bit of insight into the quality of paper being issued by firms seeking to buyout or merge with target companies.  Since 2005, C-Ls as a percent of all leveraged loans has increased 50%, with the most rapid rise beginning in 2011 and continuing to the end of 2013.

Figure 1

Given the nature of C-Ls, we could expect the issuers to appeal what would clearly be a lesser-valued asset (given the lower standards offered to market the paper), let alone one that was priced higher by the issuer. Over the past 22 months this has been the case. Those who invest in leveraged loans have benefited from the price behavior at a ratio last seen in June of 2013. This is due to issuers trying to entice new buyers with offers that are more acceptable.  

Figure 2

This increase in price which is currently benefiting the investor could be contributed to the heightened levels of M&A activity and the supply/demand dynamics. On Friday morning, a writer at Benzinga noted that the United States holds the regional lead in respects to the Value-Size of the transactions.  Figure 3 shows the US just barely leading Europe in the M&A Transaction Count comparison.  Note the increase across all regions as money that was initially in the equity markets because the FED chased it from the bond market, repositioned itself to take advantage of the expected rise in M&A activity thanks to cheap paper and a hunger from private equity for LBOs.

Figure 3

Money-managers and investors alike began to adjust to an environment of rising rates and lower expected returns in the US equities complex.  The big money has acquired and continues to acquire positions in Alternative Investments to maintain capital deployment while conversely avoiding equity drawdowns and bond market lulls.  The HFRI Fund Weighted Index and the HFRX Global Hedge Fund Index track hedge-fund performance and provide a proxy to compare returns against equity markets as hedge fund portfolios are traditionally full of Alternative Investments.

Figure 4

Media outlets lead viewers to believe that big money is backing traditional assets,  but in reality it isn’t.  That money is in the alternative asset realm.  YTD-2014 we see the positive returns already offered in mutual and high yield bonds (Figure 5).  What this means is that when the fluff generated by the Federal Reserve’s MBS and Treasury bond buying ends, the cash they chased away in search of returns that initially showed up in equity markets, bled into the Alternative Investment market through 2009 and 2010 and has since remained elevated.  Now those investors are experiencing the beginning of what will surely be a year of steady to high returns as the paper used to fund M&A continues to price itself to the benefit of the investor, as shown in Figure 2 above.

Figure 5

Last week in my Tumblr posts, I discussed the adjustments coming to the housing market and the equity market.  Again, I’m not calling this a top, but we are shrinking our time-horizons when it comes to deploying capital in the traditional equity and bond market for the coming 8-16 months.  The FED has over inflated traditional asset classes and once the FED leaves, the base we think is there is actually parked comfortably in alternative assets.  Let’s finish with a look at Money Market Funds since 2009, which are down for both institutions and retail.  The foundation isn’t what it was and once this temporary one formed by the FED is removed, the mold won’t be strong enough to replace it. 

Figure 6

Take advantage of the time available my friends and do your research to make sure you can stand firm in your convictions. Don’t rest on your previous performance or ability.  Maybe the coming FED action won’t be drastic, but it surely will cause volatility and no one wants to be caught on the short end of that stick for a prolonged period of time. Be alert and stay informed.