Event-driven funds have come in for a bit of a battering in recent years, thanks largely to the exploits of Bill Ackman and David Einhorn.
Those giants of the hedge fund world had built up big reputations, and huge assets, on stellar performance records, before both suffering heavy falls in 2015, with only Einhorn recovering some ground the following year.
In the mutual funds world, event-driven funds haven’t dealt investors quite as much drama, but it has proved a fallow period for many, with only one manager, Fidelity’s Arvind Navaratnam, managing to deliver double-digit returns over the last three years.
Navaratnam has not just edged his way ahead of the opposition, but returned 33.8% on his $345 million Fidelity Event Driven Opportunities fund, more than three times higher than those of his nearest rival, Thomas Kirchner, manager of the Quaker Event Arbitrage fund.
It’s been a steep path to the top for the 34-year-old portfolio manager. He only joined Fidelity as a life sciences analyst in 2010, finding his niche in identifying stocks mispriced due to corporate actions, such as spinoffs, bankruptcy or management change.
After pitching the idea to his bosses, he ran a test portfolio that was successful enough for Fidelity to launch the fund, alongside the Fidelity Advisor version of the portfolio, in 2013.
Navaratnam has outpaced the S&P 500 since launch
Go your own way
Navaratnam’s approach is one that puts him at odds with many in the event-driven investment sector. 40 Act rules already soften the excesses of the hedge fund world for mutual fund investors, by placing restrictions on borrowing and short selling, and prohibiting performance fees.
But Navaratnam goes further than this, in not shorting stocks at all. ‘I don’t like to take asymmetric bets,’ he says, explaining that while the best case scenario for a shorting strategy is to double your money, the potential downside is limitless. Consider the plight of anyone who shorted Amazon stock, up by more than 2,000% over the past 10 years, for example.
And while his investment philosophy is based upon identifying mispriced securities, it’s not a short-term, take-the-money-and-run approach. ‘I like to think of myself over a long period of time as an owner of the business,’ he says of the stocks he backs.
All of this isn’t sounding very event-driven, lacking the aggressive short-term bets and shorting that have characterized the sector. Navaratnam agrees.
‘Frankly, when we launched I didn’t love the name Event Driven,’ he says. ‘Many of those funds focus on a corporate action that could be very brief. But the marketing team thought that was the most appropriate name.’
Not that this means Navaratnam won’t act quickly and with conviction when he sees an opportunity, such as with his current top holding, oil services firm Exterran, representing 9.5% of the Advisor portfolio.
Navaratnam aggressively built up his holding in the summer, as the stock traded under the cloud of accounting irregularities, forcing the company to restate its 2015 results.
Sentiment had turned so bearish against the stock that Navaratnam calculated its market capitalization was worth less than its compressors used for its services. With 2015 results restated earlier this year, the stock has climbed 87.4% over the past six months. ‘Frankly, I hope I get more of these,’ Navaratnam says.
Another success, perhaps more in keeping with the approach of his event-driven peers, was Navartnam’s stakes, now sold, in Fannie Mae and Freddie Mac. Occupying only a ‘small tail’ in the fund, the stocks offered the sort of asymmetric bet that was more to his liking: a worst-case scenario of losing the money versus a best case of making multiples, or ‘a lottery ticket,’ as Navaratnam puts it.
Although the government-sponsored enterprises fell heavily in February after a federal appeals court barred a challenge to their amended bailout, under which the firms pay all of their profits to the government as dividends, that was after a big rally in the stock sparked by Donald Trump’s election as president.
The Nascent Fidelity Event-Driven Opportunities fund has attracted $240 million of net assets over the past three years
Learning from the lows
But Navartnam’s portfolio is not full of unqualified successes, and it is his mistakes that he pays particular attention to. Although the manager’s approach may share little with that of Ackman, they have both made the mistake of investing in troubled pharmaceuticals stock Valeant, albeit in the Fidelity manager’s case, with much less severe consequences.
‘Valeant was a clear mistake on my part,’ Navaratnam says. ‘I like to study my mistakes, that’s how you learn from them.’
The only positive he can draw from his investment was that ‘I sized it well’: at the end of February, the stock represented less than a quarter of a percent of the Advisor portfolio.
Although Navatnam’s performance has taken him to the top of the sector, it’s worth noting that it hasn’t always been a smooth ride: the Advisor fund has a maximum drawdown of 14% over three years, among the highest of his peers.
‘This is not a linear return strategy,’ he says, and the manager will feel the ups and downs as acutely as his investors. ‘My wife and I have the majority of our net worth in this,’ he adds.
But the upside of that return profile is that investors have enjoyed a near 20% gain over the past six months. While success stories such as Exterran have been a driver of those returns, the fund was also carried by the explosive rally in small-cap shares following Donald Trump’s election as US president.
Navaratnam says the fund’s small-cap bias was due to it being much more likely to yield the kind of corporate special situations he hunts for.
The fund’s biggest sector allocations, and heaviest overweights, are to the information technology and consumer discretionary sectors, accounting for more than 46% of the fund. But Navaratnam emphasises sector allocation plays a small role in his bottom-up investment approach.
‘I don’t think about sector allocation,’ he says. ‘I start by asking why something might be structurally mispriced and evaluate it. It has to be a situation where I feel it can double or triple in two to three years.’
The volatile approach has delivered high returns
The vertical axis shows the three-year standard deviation percentile rank, the horizontal shows three-year total return. The size of the bubbles shows manager market share. Analysis at February 28 2017. For more details, contact email@example.com