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The Merger Boom Opens an Opportunity

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The Merger Boom Opens an Opportunity The Conservative Strategist is researched, edited, and published quarterly by Robert J. Gavrich of Seasonal Strategy, an investment adviser licensed with, and subject to examination by, the California Department of Business Oversight. All contents contained herein are derived from data believed to be reliable, but accuracy cannot be guaranteed. Bear in mind that past performance does not guarantee future results. The officers of Seasonal Strategy may from time to time hold positions in securities mentioned in this newsletter. The information and opinions herein are subject to change without notice. Reproduction in whole or in part without the express written consent of Seasonal Strategy is prohibited. Form ADV-II available upon request. Robert J. Gavrich Phone 415.956.1721 CA-Licensed Investment Adviser Fax 415.956.1722 President, Seasonal Strategy Email [email protected] 1517 Fountain Street • Alameda, CA 94501 ©2018 Seasonal Strategy seasonalstrategy.com THE CONSERVATIVE STRATEGIST OCTOBER 2018 OCTOBER 2018 A QUARTERLY INVESTMENT Trump gets one right NEWSLETTER The merger boom opens an opportunity midst all the havoc created increased by an estimated 4.5 years. selective distributions from retirement PUBLISHED e’re living through a veri- A non-directional strategy by the Trump Administration, So the suggested increase in manda- accounts. EXCLUSIVELY table flood of mergers, with Merger Fund performance in ten negative quarters for S&P, 2008-2015 there’s the occasionally shock- tory RMD age of 4.5 years matches the 2018 expected to break all Some may see in this proposal just FOR CLIENTS -3.8 A W Q1 2008 -9.4 ingly reasonable proposal. One such longer life expectancies. Since RMDs records, perhaps approaching $4.5 0.6 another gift to the investor class. Q2 2008 -2.7 1.7 instance: In late August, Trump issued are meant to cover remaining life OF SEASONAL trillion. It’s both a signal and an op- Q3 2008 -8.4 But it also rewards diligent lifetime -0.7 Q4 2008 -21.9 an executive order compelling the Trea- needs, this only seems right. portunity. 2.5 savings, addresses that age 70 tax STRATEGY Q1 2009 -11.0 -1.5 sury Department to review the rules Q2 2009 -11.4 We work longer bump, and delivers more autonomy Signal: US Stocks -4.0 governing Required Minimum Distribu- Q2 2010 -13.9 0.1 and choice up to taxpayers. It would offer no margin for error Q3 2011 -2.8 tions (RMDs) from retirement accounts. Second, we’re working longer. Since 1.3 be an incremental win for retirement Q2 2012 -0.4 -2.7 The Trump Administration recommend- the mid-80s, the over-55s are the Ominously, the last two times mergers Q3 2015 -6.4 security. ed on Thursday that the age at which only age group which exhibits steadily approached current levels were early -24.0 -22.0 -20.0 -18.0 -16.0 -14.0 -12.0 -10.0-8.0-6.0-4.0-2.0 0.0 2.04.0 Merger Investor S&P 500 TR (1989) RETURN RMDs must be raised from age 70½ to rising labor force participation rates. [One final outbreak of sensibility: The 2000 (remember AOL/Time Warner?) In ten worst quarters for S&P shown, Merger was positive in five, and outperformed S&P in all ten. age 75. This proposal seems overdue, Some are working out of need, others administration is recommending that and mid-2007 (Alcoa/Alcan, Thom- Source: Westchester Capital Management for at least three reasons. by choice. Regardless of motivation, the life expectancy tables upon which son/Reuters, and many others). Both working past age 70 means paying RMDs are based be updated. They are merger booms coincided with major itself removes much of the volatility in such as an early deal closure or a bid- We live longer taxes on two streams of income: work 16 years old at present, and life ex- market tops and ushered in brutal bear the stock, and it tends to drift higher ding war over the target stock. toward the acquisition/merger price as First, we’re all living longer. Since income and Social Security income, pectancies, as noted, have advanced markets. Why now for merger arbitrage? 1974, when the original IRA legislation which must be taken by age 70. It’s considerably. Revised tables will mean the proposed closure date approaches. Is history repeating? Let’s put it this was passed, the life expectancy of the adding insult to also compel this slightly lower RMDs each year.] n With much of the uncertainty and Up ‘til about 2015-2016, merger arb way: The cyclically-adjusted price/ average 65-year-old (both sexes) has cohort to take RMDs at age 70½ they volatility removed, the merger arbitra- saw some lean years. The strategy earnings ratio (known as CAPE) of US may not want or need while still earn- geur seeks to capture that modest but depends largely on deal flow and Merger boom stocks has reached 33, equal to that ing income. Doing so may only incur reasonably reliable profit. short-term interest rates, and for years Ed Slott weighs in (Continued from page 1) of the 1929 top and topped only by unnecessary taxation, and even send both were notably low. Spreads (the n a few months in late 1999 and early Can things go wrong? Yes, the deal Raise the mandatory RMD age them into a higher tax bracket. Fast forward to 2018. Corporate potential percentage profit in the aver- 2000. The risk/reward scenario for US can take longer than expected to final- to 80 — or eliminate it alto- tax cuts. Repatriations. Deregula- age merger arbitrage) were skimpy, Conversely, raising the manda- Stocks today is uniformly awful. ize, lowering the annualized return. gether. tion. Firms find themselves flush in the low single-digits. Merger arbs tory RMD age to 75 will allow older Occasionally, a deal even busts over n RMDs particularly onerous to with cash, and with much of the Merger arbitrage couldn’t make much of a living after workers to smooth their tax burden. antitrust or other concerns. But things working seniors. growth-by-cost-cutting behind expenses. Many folded up shop. Another benefit of raising the manda- Is there perhaps a better way to capi- can go better than expected as well, them, they are incentivized to grow (Continued on page 4) n No one should be forced to pull tory RMD age is an IRA balance that’s talize on the merger boom? Yes, there by acquisition. The Markets September 28, 2018 Price/Yield Gain, Qtr Gain, YTD money out of IRA while they’re allowed to grow for 4½ more years is. Today, merger arbitrage offers a far working. tax-deferred, possibly resulting in 20% So mergers are booming again, but more attractive risk/reward ratio than US Stocks (S&P 500/Vanguard Index) 2913.98 7.67% 10.44% n Seniors who wish to withdraw to 30% additional growth. many of the arbs who kept spreads owning US stocks outright. International Stocks (Vanguard Index) 17.36 -0.44% -4.01% compressed have long since left Emerging Markets Stocks (Vanguard Index) 25.99 -1.79% -8.95% earlier can do so voluntarily. We need to tax plan Merger arb, as it is called, is the pur- the business. Abundant supply of n 70½? At the very least, elimi- chase of the stock of a merger targets Real Estate Stocks (Vanguard REIT Index) 26.81 7.81% -1.89% Third, the proposal allows for en- merger deals combined with limited nate the half-year nonsense. after a deal has been announced. Why Bonds (30 year US Treasury/Vanguard Index) 3.19% 0.50% 0.41% hanced flexibility and control over demand from arbitrageurs means Make it 70. after? Because after an announcement Dollar (US Dollar Index) 95.19 0.58% 3.33% retirement income. It gives you more the annualized returns of spreads is made and the target stock pops Ed Slott, CPA,is one of America’s foremost time to engage in tax planning, in- on new deals are at their highest in Gold (London Afternoon Fix) $1185.40 -5.35% -8.32% experts on IRAs and retirement account higher, there nearly always remains a planning. Source: MarketWatch cluding Roth conversions and/or more than a decade. n Money Market Funds (Vanguard Prime – SEC yield) 2.13% +0.10% +0.77%* little profit in the deal. Also, the pop *change in yield PICKS & PANS Portfolio SuperDiversified Deal flow just one sign Planning Two funds for the merger boom Portfolios (SDPs) Merger ETFs... of overheated market t may be timely to add to our The merger arb business is legal-re- BlackRock Event-Driven Up to snuff? merger arbitrage exposure in two search-intensive and so requires expe- Institutional (BILPX) industry stalwarts — one helmed rience and scale. The Merger team has SDP1 Conservative SDP2 Moderate n most asset classes, exchange-traded funds, or I Flexibility and risk control ETFs, are an excellent alternative to open-end by a time-tested team of veterans, the analyzed more than 4,500 deals over If you started your own merger fund, other by a hedge fund superstar. Both 30 years, building a comprehensive Imutual funds. They offer index exposure, low and you could cherry-pick its man- have delivered modest but steady database that helps them to evaluate 20% 20% 20% fees, and tax-efficiency. ager, you couldn’t do much better Real Assets 30% Real Assets US Stock returns with very low correlation to merger risk in a granular way. SuperCash But what about merger arbitrage? Are there ETFs our other asset classes, and even our than Mark McKenna.
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