September 16, 2022

Investors Look to Alternative Event Driven Funds Preparing for the Next Credit Cycle

by Jack Fischer.

Lipper Alternative Event Driven Funds (AED) are funds that, by prospectus language, seek to exploit pricing inefficiencies that may occur before or after a corporate event, such as bankruptcy, merger, acquisition, or spinoff. Lipper Event Driven Funds can invest in equities, investment grade debt, high yield debt, bank debt, convertible debt, distressed debt, and derivatives.

This past week the European Central Bank (ECB) announced its largest rate hike—75 basis points (bps)—in its 24-year history. In the U.S., the consensus is that the Federal Reserve will raise interest rates by at least 75 bps in next week’s meeting. With central banks around the world rapidly tightening their monetary policy to fight the onslaught of pervasive inflation, the question becomes: is a soft landing still a feasible outcome if we truly want to regain control of asset prices?

On Tuesday, September 13, the Department of Labor (DOL) reported the August Consumer Price Index (CPI) increased year over year by 8.3%, which was below July’s 8.5% increase but above economists’ estimates. The month-over-month increase was 0.1%, when economists forecasted a drop. Energy costs fell 5%, helped by gas prices falling 10.6%—gas prices were still 25.6% higher than they were in 2021. The unexpected print caused U.S. equity markets to tumble on the day—the Nasdaq (-5.16%), S&P 500 (-4.32%), and DJIA (-3.94%) suffered their worst daily session in more than one year.

Each credit cycle brings certain nuances, but one thing has remained somewhat consistent—when savings are high, the cost of borrowing lessens, leading to inflated asset prices and valuations. With mispriced asset prices come corrections, and that’s where Lipper Alternative Event Driven Funds look to jump in. So, are we in store for another credit cycle?

High Yield Corporate Bond Issuance

Two things have been abundantly clear, global high yield bond issuance has fallen dramatically, both in volume and issue amounts, after a record year in both. With interest rates increasing and economic conditions tightening, both credit growth and risk appetites are slowing.

Another indicator that has been coming into focus is the declining savings rates versus growing household debt. As individual household balance sheets begin to tighten, more and more individuals turn to credit to finance purchases, which with higher interest rates and rising asset prices has the potential to be troublesome, to say the least.

Household savings as a percent of disposable income

Household debt as a percent of disposable income

So how have Alternative Even Driven Funds been faring? The Lipper classification attracted its second-largest first-half intake on record (+$1.8 billion)—the record being the first half of 2021 (+$3.2 billion). This past fund flows week AED funds pulled in $75.4 million, marking their seventh weekly inflow in the past eight. On average, funds within the classification returned a positive 0.25% over the week.

Alternative Even Driven Funds

Funds within this classification have been gaining popularity year over year. AUM for the classification has increased for six straight years. The AUM at the end of 2021 and the end of August stood at $19.7 billion and $22.1 billion, respectively.

If and when the next credit cycle comes, AED funds will be looking to take full advantage of financial and strategic restructuring brought on by low liquidity, risk appetite, and economic growth.

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