Gordan Gekko Said It Best
In the 1987 finance classic, Wall Street, Gordon Gekko famously told his young and eager, but unproven protege, “I don’t throw darts at a board. I bet on sure things. Read Sun-tzu, The Art Of War. Every battle is won before it is ever fought.” While this may be a line from a fictional movie to a fictional character, the underlying statement is as non-fiction as it gets when it comes to the mentality of fund managers — especially those with a track record of success in every stage of the market cycle.
Let’s put it this way, do you think Warren Buffett has made tens of billions of dollars by “throwing darts at a board”? That would make him the luckiest man who ever lived on planet earth, or perhaps someone from the future gave him 70 years of Wall Street Journal’s akin to Biff Tannin and his Gray Sports Almanac a la Back to The Future 2. Unfortunately, none of these scenarios are true.
While luck (the intersection of opportunity and preparation) has certainly played a role in Warren’s success, he is also a brilliant financial mind who works incredibly hard to discern what he believes are “sure things” in the marketplace. I like to compare the approach of historically successful fund managers to successful blackjack card counters, where Warren Buffett is the famed Bill Kaplan and all the managers together are MIT’s Blackjack Team. Now, while it would be wonderful if we could all wake up one day and be as talented at discerning sure things as Warren Buffet, unfortunately there is more than just raw talent and hard work that goes into a track record of successfully picking winners. Wall Street is a world of revolving doors powered by nepotism and back room conversations, for every retail loser there is an institutional winner who simply has access to more knowledge. Even if you are smarter than Warren Buffet and harder working, you do not have his rolodex and likely never will.
While we all certainly might wish we had the foresight to buy Microsoft stock in the late 80’s, the truth of the matter is the majority of us were likely busy using our typewriters while Warren was busy having lunch with Bill Gate’s as he explained his vision of Microsoft and the future. Now, if you are a retail investor new to the market in 2020, starting to undoubtedly feel like you’d have equal luck if not better on the casino floor — I’m here to tell you that doesn’t have to be the case. Thankfully, unlike the heavily unregulated casino floors where the house always wins, the stock market is a heavily regulated domain and within these regulations lies the SEC’s Form 13F.
SEC 13F Form’s are quarterly reports that require all institutions with over $100M in assets under management to publicly disclose their equity holdings. Congress created the 13F requirement in 1975 with the intent to provide the U.S. public a view of the holdings of the nation’s largest institutional investors, AKA “smart money”. While 2020 has certainly proven to be an unpredictable year, if there is one thing we can safely predict now — it’s just that, unpredictability or in market verbiage, volatility.
In volatile markets such as these, there is no better time to look for sure things and one way to do that is by carefully analyzing 13F’s and riding the coattails of those who simply have the most access to information. We need only look back to another Gordan Gekko quote, “the most valuable commodity I know of is information.”
Where to Look
Now, while one might be quick to look towards the PIMCO’s and BlackRock’s of the world for insight, they will quickly find that these firms are so absurdly large (it seems at times like BlackRock is literally invested in every publicly traded company worldwide) that the noise makes it almost impossible to pick any clear cut strategies or winners from their shotgun like approach. Similarly, when one looks toward established portfolios like Berkshire Hathaway, they’ll find bets that will surely pay off over the long run, but I don’t think you are still reading this article in search of a ten year play. Thus, we find ourselves at a crossroads, we need to look for shorter term “sure things.” In uncertain times such as these, I fall back and rely on age-old arbitrage opportunities, specifically merger arbitrage. Simply put, arbitrage is a scenario whereby one takes advantage of price inefficiencies or differences seeking to profit off of these imbalances in the marketplace. Merger arbitrage, otherwise known as risk arbitrage, is an investment strategy that speculates on the successful completion of mergers and acquisitions thus taking advantage of inherent market inefficiencies surrounding mergers and acquisitions themselves.
Why Merger Arbitrage?
The reason I look toward merger arbitrage is because the concept is relatively simple to understand, it’s easy to track hedge funds in the space, it’s easy to check those funds historical successes and most importantly, it’s safe to assume that any fund putting 30% of their portfolio toward a single holding knows something we do not. When you add these aforementioned components together, you get the most attractive “sure thing” plays during these uncertain and trying times.
Which Funds to Track?
I like to target “smaller funds”, between $300mm and $1bn in assets under management that typically put large percentages of their portfolio toward singular plays. My reasoning behind this comes from my firm belief in Nobel Prize winning economist, Daniel Kahneman, and his work on loss aversion. Loss aversion is the psychological conclusion that people lose more satisfaction than they would gain from an equal but opposite loss or gain in capital respectively. In simple terms, it hurts about twice as much to lose $100 than it feels good to make $100. With this in mind, it is safer to assume that the smaller smart money funds who repeatedly play in the merger arbitrage space with large portions of their portfolio allocated to singular plays at any given time, are more likely to know something the general public does not. This is of course because the potential pain of a total loss is greater than the joy from any potential gain. With all of this in mind, one example fund I like to track closely is a group called Maso Capital out of Hong Kong. I first became aware of Maso Capital during my daily Bloomberg reading back in 2012 (Article) when I saw that two managing directors of Och-Ziff, one of the largest most successful hedge funds in the world and one I’ve tracked for over a decade, were leaving to start their own fund. In particular, these two individuals, Manoj Jain and Sohit Khurana were in charge of none other than Och-Ziff’s event-driven equities and merger-arbitrage departments for all of Asia; big swingers no doubt. Being two of the most experienced merger-arbitrage guys in all of Asia, coming out of one of the most globally recognized funds in the world, I understandably took note. While tracking smaller sized funds out of Asia might seem a little obtuse, I should reference back to my earlier points that it can safely be assumed fund managers with a track record of success often times have greater access to information than the average retail investor. This assumption is furthermore compounded greatly by a geographical component when it comes to Asia, where historically, information seems to flow quite easily between the powers that be.
The biggest opportunity I see right now is with Genworth Financial (NYSE: GNW). Genworth first grabbed my attention when I saw that Maso Capital had bought 6.5mm shares in their 13F released at the end of the 2nd quarter back in May. Despite the fact that the shares faltered during Q3, Maso Capital again increased their holdings bringing the total up to just under 7m shares by the end of Q3 ending in August. At this point in time, Genworth accounts for just under 10% of their funds total holdings. The deal — a long time proposed merger between Genworth Financial and China Oceanwide Holdings. Oceanwide is an investment group based in China that’s currently traded on the Hong Kong stock exchange, a fact that certainly plays into the hands of Maso Capital and the underlying strategy of following the smart money with the most information. Taking a closer look at the deal, the proposition is nothing new and negotiations have been ongoing for about 4 years. That said, things have clearly heated up recently, including a press release that the two sides avoided a termination clause of August 31, 2020 and are inline to complete the merger by September 30, 2020. The $2.7bn deal would be entirely financed and would instantaneously prescribe a minimum fair value of $5.43 per share of Genworth stock, currently hovering around $3.00 at the time this piece was written — constituting an 81% upside. By no means am I the only one who is aware of this impending merger, I’m simply providing a deeper insight into the situation as well as my overall strategy when it comes to merger arbitrage. On SeekingAlpha alone, more than 5 articles (Merger Arbitrage Mondays – Rosetta Stone Acquired At A Huge Premium, Genworth schedules annual meeting as Oceanwide works on closing merger (NYSE:GNW), 50% Upside On Oceanwide Closing On Genworth For 18 Cents On Dollar (NYSE:GNW), Merger Arbitrage Mondays – Condor Hospitality Terminates Merger Agreement With NHT Operating Partnership, Genworth: Transaction Progress In A Tough Year (NYSE:GNW), Genworth Financial: Limited Downside Risk Remains (NYSE:GNW)) have been published since the beginning of September. Lucky for you though, the share price has become even more affordable since those previous articles were published.
If you, like many other retail investors, are tired of chasing trends only to see your portfolio in the red, I’m here to tell you that you are not alone. The market in general is rigged for institutional holders, especially during volatile times like these. However, there are ways for you to ride the smart money coattails, and if you play your cards right and swallow your ego, you too can start to reap the rewards of information and surety. While nothing is ever entirely a “sure thing”, I think the only shaky assumption left here is the true close date of the merger, and judging by the moves that Maso Capital has made, I think that date is finally upon us. The facts stand that Genworth Financial will close on its merger with Oceanwide and the deal price will be $5.43, thus presenting a relatively low risk, high reward opportunity that doesn’t come around all too often. You can see a lot of my own due diligence and research goes into tracking funds. Hopefully this has given you an idea, an opportunity and if nothing else, a roadmap and rubric for finding your own funds. Tracking the right funds will allow you to leverage their information for your own benefit. This is an especially powerful strategy at times when you don’t have strong feelings about anything on the market and begin to feel like you’d be better off on the casino floor rolling dice.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in GNW over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Will open a long position in GNW at the beginning of next week.