Corporate control on the cheap?

A couple of years ago, I got into the guts of the Melrose Industries hostile takeover of GKN. This deal squeaked through, despite it being opposed by GKN employees.

The bit of it that particularly interested me was the role of hedge funds doing the merger arbitrage trade, which ended up influencing a major part of GKN's shares (and simultaneously shorting Melrose). I say 'influencing' as the overwhelming majority of the funds' exposure to GKN was through derivatives, rather than ownership of its shares. 

My understanding of how this corner world works is that hedge funds utilise equity derivatives primarily because they are cheap. It costs a lot of money to buy 1% of a PLC, and if a hedge fund with a few billion under management went out and bought the shares it would represent both a big expenditure and a very significant position. So using CFDs or swaps enables them to gain exposure to movement in the target's shares without having to pay to own the underlying asset. They obviously pay for the derivative itself, but that's a fraction of the cost of the underlying equity.

As I blogged previously about GKN, my understanding is that, as the counter parties to the derivatives, investment banks end up holding shares. Again, no problem in principle, and everyone is clear that it is the hedge funds which have the economic interest in the shares even if they don't own them. If the hedge funds have long derivatives they make money if the shares go up and lose it if they go down. That in turn means that if the bid fails they lose money, so holders of long derivatives obviously want the bid to succeed (or look to be set to do so - if they got in early they could take profits before the outcome is decided I suppose).

In a hostile bid the bidder essentially makes an offer over the heads of the incumbent management of the target to the company's shareholders. Those shareholders in turn have to decide by a set deadline whether or not to accept that offer. If you're a shareholder you can accept that offer or not (and the management of the target will be telling you to ignore it) and if you're not a shareholder you can't. And by extension, if you hold derivatives, not shares, you're not a shareholder. So you can't respond to the bid. 

So far so simple. But what if you're an investment bank that holds the shares as a counterparty to a derivative holder? You do hold the shares, but only because of the derivatives. How do you decide how to respond? Pure survival instinct is surely going to tip you to support the bid because you know that your valuable hedge fund client is going to lose money if the bid looks like it might fail. It is possible, even, that the derivative is written in a way that stipulates this, though I simply do not know if this is the case or not.

My issue is that this may mean that de facto those holding derivatives are able to exercise influence on the outcome of bid equivalent to that of an investor holding equity. If so this is influencing what we used to call the market for corporate control on the cheap. It doesn't feel right to me that investors whose only interest is in an instrument that mirrors the share price, and its appreciation during the limited timeframe of the process a bid, should be able to influence the ownership of major employers.

I could be off-target on some of this so would welcome any corrections etc from anyone who knows this area better than I do. I will keep private just email if you don't want to comment on here. (I'd also be interested to find out how much gaining an exposure of say 1% via derivatives actually costs vs buying the shares.) But I think I do have the outlines broadly right. If so, I think this ought to attract more attention than it does currently. 

PS. Given that a change in ownership is absolutely fundamental to a company's future this is very obviously a significant stewardship issue. Yet, as I've blogged before, a number of the funds active in the merger arbitrage market do not adhere to the Stewardship Code.

Shire takeover & derivatives

So the takeover of Shire PLC by Takeda Pharma has been completed. I thought I'd have a quick look for merger arbitrage plays in the filings.

A few familiar names in the list below. Most of these investors are listed as having an interest (presumably short) in Takeda too and I've found a couple of examples:

Millennium - 0.68% in shares, 2.28% in derivatives
York Capital - 1.51% in derivatives
Marshall Wace - 0.3% in shares, 0.7% in derivatives
DE Shaw - 0.54% in shares, 1.07% in derivatives (Takeda short here)
Davidson Kempner - 1.39% in shares
UBS O Connor - 1.03% in derivatives
HBK Investments - 0.17% in shares, 3.08% in derivatives
Elliott - 0.0002% [chuckle] in shares, 1.28% in derivatives (Takeda short here)

This is just from a quick Google. Final positions may have been high/lower. But doesn't take long to get to 10%+ interest through derivatives.

NEX Group takeover & derivatives

Another takeover, another example of hedge funds piling in using derivatives. In this case its NEX Group, which is being taken over by US-listed CME Group. It's not hostile so it went to a vote and got a strong thumbs up.

I find this one interesting as it's another example of hedge funds running the merger arbitrage trade, albeit in uncontested circumstances. This is classic 'picking up pennies in front of a steamroller' behaviour. They are taking a punt on being to skim a bit off expected price movements (upwards in the target, downwards in the bidder). As far as I can see no-one claims there is any kind of market inefficiency that this behaviour is ironing out.

Anyhow, here's who is in the mix using derivatives, based on a quick trawl of rule 8.3 disclosures.

York Capital  (also active in GKN/Melrose) with 4.63%

Magnetar Capital - 1.2%

Carlson Capital - 1.95%

Omni Partners - 1.13%

TIG Partners - 1.27%

UBS O' Connor - 1.02%

PSquared - 1.9%

Sand Grove - 1.61%

Alpine Associates - 1.5%

Merger arbitrage in practice: Sand Grove Capital

Given the renewed interest in financial market activity around mergers and acquisitions, I thought it might be interesting to have a look at the regulatory disclosures for one of the funds that has caught my eye lately.

I hadn't heard of Sand Grove Capital until recently, but it ended up taking a sizeable (almost 3% at one point) short position in Melrose Industries in the run-up to the acceptance of its bid for GKN.

Here it is at play in the bid - long GKN 1.27% using CFDs on 12th March and short Melrose 2.09% also using CFDs on 14th March.

There's a similar story in the GVC/Ladbrokes takeover. Here is Sand Grove long Ladbrokes 2.1% on 19th March using CFDs and short GVC 1.87% also using CFDs on the same day. 

And we see the same thing with Tesco/Booker. Here is Sand Grove long Booker 1.17% using CFDs on 7 Feb and short Tesco 0.22% using CFDs on 8 Feb.

And here are a few more examples of Sand Grove's position in UK PLC that are/were potential or actual takeover targets - Fenner (long 3.63% using CFDs, 5 April), Fidessa (long 1.39% using CFDs, 18 April), Sportech (long 8.91% using CFDs, 8 January), Sevelec (long 3.17% using CFDs, Nov 2017) and Brammer (long 4.67% using CFDs, Dec 2016).

Obviously, their main approach is to gain exposure through derivatives. On a quick search I could only find one disclosure - in respect of Revolution Bars - where there was an actual shareholding. This was reduced later, according to reports, when a takeover was rebuffed.

Stewardship

What I couldn't see on the Sand Grove Capital website was a a Stewardship Code statement. Just as a reminder, the FCA Conduct of Business rules say:

A firm, other than a venture capital firm, which is managing investments for a professional client that is not a natural person must disclose clearly on its website, or if it does not have a website in another accessible form:

1. (1) 
   the nature of its commitment to the Financial Reporting Council’s Stewardship Code; or

1. (2) 
   where it does not commit to the Code, its alternative investment strategy.

I can't see a statement on the website, but, weirdly, you can access a statement via this site which does third party hosting for regulatory disclosures. The Sand Grove statement is here. If you can't be bothered read it, here's the key bit:

The Firm manages event-driven strategies involving a variety of asset classes, global jurisdictions and timeframes, and approaches companies and their managements on a case-by-case basis. Therefore, while the Firm supports the principles of the Code, it does not consider it appropriate to conform to the Code at this time. 

If you stick the second sentence into Google you get a few other hits for hedge funds that coincidentally came up with the same set of words. Spooky.

GKN takeover - losing the battle, winning the war

Few things have made me as angry recently as the Melrose takeover bid for GKN. This bid was opposed by a very wide group - workers, unions, GKN customers, Labour, some Tories, the Daily Mail, most of the large long-term GKN shareholders - yet it got over the line because of the support for merger arbitrage funds (or "arbs" as they are known in the City).

I think the labour movement can learn a lot of lessons from GKN, and see this as an area where we can do some fruitful work. If we don't want hedge funds to prevail we have to figure out how to beat them. So here are some of my thoughts.

Two killer facts: the arbs won it, and most arbs were not shareholders 

It's important to be absolutely clear about two things when looking at the Brexit-shaped 52% result in favour of the bid. First, Melrose could not have won without the arbs. Second, many of the arbs were not shareholders. I say we need to be clear about these things, because a lot of the reporting of this bid has failed to grasp these important facts.

On the first point, if hedge funds accounted for 20% to 30% of the control of GKN shares, then this accounts for about 40% to 60% of the support for Melrose. In this bid, compared to other cases, they were not bit players they were absolutely central to Melrose's victory. To repeat: Melrose could not have won without them. They may not even have come close. Melrose was expecting these funds to support it, but I doubt they had an inkling of how much they would need that support (remember they initially set the acceptance level at 90%!). This from the FT today makes the point:

Incidentally, that means that GKN's FD was correct in his claim last weekend (which GKN had to retract on Monday) that the company had the support of most long-only shareholders. Assuming that the figures for hedge fund control of GKN shares are about right - GKN likely had the support of around two thirds of the remainder of the shareholder base.

The second point is just as important. Most of the arbs were not shareholders. When Elliott announced its support for Melrose last Friday this was reported far and wide as backing from GKN's "second largest shareholder". (I believe it was briefed to City journos by Melrose's PR firm in these terms, more below). But as I blogged previously Elliott isn't a shareholder, it holds contracts for difference (CFDs). The same goes for hedge funds like Och Ziff, Sand Grove, Davidson Kempner, Melqart, Man Group (actually a mix of shares and CFDs in the last case, but more of the latter). The disclosed CFD positions for Elliott and those other five investors alone is over 9.5%. (PS here's an example of what it looks like when an investor does hold shares - they fill in a different part of the box on the form.)

Still not convinced? Look at GKN's list of major shareholders which lists holders with 3%+. Elliot's position was 3.84%, so where is it?

No Elliott, but getting on for 16% held by two US banks. In fact, the big positions in GKN shares held by the banks was one of the things that first revealed that hedge funds were swarming in. The banks are the counter parties that facilitate what the hedge funds do, and it is they, not the hedge funds, that hold the GKN shares. There was a good Lex piece about this earlier in the week but it is paywalled. 

So it's simply not correct that many of the arbs were "shareholders". Their exposure was via derivatives. When I posted a link to Elliott's disclosure on Linkedin and highlighted the fact its interest was through CFDs it got the most traffic of anything I've ever posted on there, and prompted some interesting comments. As mentioned above, I believe that Montfort, the PR firm advising Melrose, briefed journos about Elliot's support for the bid describing them as GKN's second largest shareholder, even though they don't own shares. There is a question in my mind as to whether this counts as an unverified claim of support, though perhaps I'm splitting hairs.

Why does any of this matter? Put it together - Melrose wouldn't have won without the arbs, and many of the arbs didn't hold shares. So bid was forced through by investors who didn't even hold shares. That is pretty shocking, but the point hasn't really been made effectively in much of the bid coverage.

Outstanding questions about CFDs

The fact that most people kept describing the arbs as "shareholders" showed that little attention was being paid to the detail of the bid. A question that still hasn't been answered as far as I am aware is how the arbs actually related to the bid.

The offer that Melrose made was to GKN shareholders, but, as described above, Elliott et al are not shareholders. So does that mean that Goldmans etc tender their shares by reference to what the arbs wanted to do? I'm guessing that they do but we really need to bottom this out.

Another question that has come up is whether the CFDs enable the hedge funds to vote. Voting rights aren't an integral part of CFDs, but I have been told by a couple of people that hedge funds can and do gain these when they want to. Basically the contract with the counterparty can be written how you want it.

But in any case in this bid it didn't matter because there wasn't a vote - shareholders had to respond to the offer or not. Hence the Melrose statement talks about "acceptances" not votes. This is something I hadn't really grasped. And actually the hedge funds and their bank allies didn't want a vote as it crystallises a tax liability. Here's Lex:

These hedgies, or “merger arbs”, have converged on Goldman, BofA and Deutsche because they are not advising GKN or quoted private equity group Melrose. The theory is that these neutral “prime brokers” can tender collateral shares held on clients’ behalf with fewer conflicts of interest. The broader advantage of prime brokers is that they are exempt from stamp duty. This means clients can generally buy and sell shares tax-free at arm’s length. If they vote the shares, they could crystallise a liability. Experts say the danger of that is less in a hostile bid, where investors show support by tendering shares to the bidder.

When there is a look at takeover rules as a result of this bid this is an area that needs real scrutiny. Should we really allow investors without shares, who hold derivatives because it's tax efficient, to affect the outcome of bids? I need a lot convincing that the answer to this is "yes".

The short part of the bid

Lots of people, me included, have learnt a lot more about hedge funds and the merger arbitrage business as a result of this bid. This is an inherently good thing. Union staff and MPs who a few weeks ago wouldn't even of heard of merger arbitrage now know the basics of how it works, and who the main players are. The shorting aspect of it has attracted quite a bit of interest. 

It's worth stating that the arb trade around this bid was massive. If these funds had an influence over 20% to 30% of GKN shares, they would be shorting Melrose to the same extent. We could see in the FCA list (which shows shorts of 0.5% and up) that reported shorts hit 13.5% at one point. IHS Markit, which gets a lot more data, said the total level was over 20% according to City AM.

A union friend introduced me to the 'days to cover' calculation. I worked out based on average daily volume that at the low end of the possible total shorts (the total on the FCA list) the result would have been almost 12 days. At the top end - the IHS Market number - the result would have been closer to 24 days. That would have been a lot of money trying to close out short positions quickly if the bid had failed.

There's nothing illegal about shorting but to does drive home what the arbs are really about. It's an inherently short-termist business, and their interest is only in the dynamics of the bid, and how it affects the prices of the acquirer and the target's shares, not the companies themselves. Betting against the company whose bid you are actively working to assist is the sort of thing that bamboozles the public and makes them think that much of the City doesn't give a toss about anything other than money. And they're right.

Stewardship

To state the obvious, these funds don't care about "stewardship". Several of the funds that had big long/short positions were in the list that I compiled at the ITF of duplicate statements of non-compliance with the Stewardship Code. Again, I find incredible that funds that can determine the future of a major engineering business can get away with just putting a few sentences of copied text on their website. In our response to the FRC in addition to providing the list of duplicate statements we also recommended that the Code be expanded to capture activity around bids:

After the experience of GKN, I think we are going to need to do a lot more. I'll be following up the duplicate Code statements with regulators, but I don't see why we shouldn't ask any funds involved in merger arbitrage to make a public statement about how they do it (i.e. shares or derivatives, is it a long/short combination etc), the typical duration of their interest and so on. But really any asset manager should make clear how they approach M&A.

And what about other shareholders (actual shareholders!) in this bid? It was striking that many big investors did not get off the fence, in public. For example, the FT suggests that LGIM supported Melrose, but I haven't seen any public statement to confirm this:

We know how a few of the other shareholders went - Aviva for the bid, Columbia Threadneedle, Jupiter, Royal London etc against - but there are loads that never went public, including some of the really big ones.

Shouldn't we expect that major shareholders make their intentions known, so that clients can override them if necessary? I don't know if asset managers typically tell clients in advance how they intend to respond to takeover bids, but they ought to. I bet some clients would not want to have their shares put up in support.  

This taps into the bigger question about the extent to which investors should be public about their stewardship/engagement activity. Very big issues were raised in this bid, lots of people are concerned about it. Why should it be acceptable that the group that plays such a major role - asset managers in control of other people's money - is allowed to treat it as a private decision?

Takeovers

It is inevitable that there will be pressure to overhaul the takeover rules as a result of the GKN result. This is why I think Melrose winning on such a narrow margin is actually the worst outcome possible for the arbs. 

You can see some obvious technical tweaks that could be used to tighten up the system:

• Don't let any investors that does not have shares respond to / vote on any bid.
• Have a qualifying period to vote - you have to be on the register before the bid is announced.
• Increase the acceptance threshold. Why not make it a supermajority of 75% like a special resolution? After all this is the most fundamental decision shareholders typically have to make.

But more generally, I think it is very likely that interest will be revived in a public interest test for takeovers. This point has already been made by Jim Moore on the Indy. The FT also anticipates it:

So let's start working on what it would look like. LFIG and Policy Network already had a go so someone has already done some thinking. This needs to be turned into practical proposals that MPs can push.

Let's clip those hedges

A final point - it's time to go on the offensive. The hedge funds won this time, but it doesn't have to be this way. Let's start to challenge them - both how they operate in the market, and the influence they have more widely. Look at the money they poured into the Brexit campaign, or that they pour into the Tories' coffers. 

At the very least we should seeking to stop our pension funds from giving them any money. We should also push back on their political influence. There is a model for this. In the US labour and other groups formed the excellent Hedge Clippers campaign group. There is nothing to stop us forming something similar in the UK.

I hope that the Melrose bid for GKN can be overturned, and yesterday's result was much tighter than anyone expected at the start of the bid. But still, seeing the bad guys win is a real kick in the nuts. We should be angry about it and we should use that anger to change the system. Let's turn the the GKN arbitrage trade into the most costly bit of business that hedge funds ever did.

Elliott's support for Melrose shows why GKN must not be taken over

Yesterday afternoon, Elliott Advisers announced that it plans to support the Melrose bid for GKN. This was duly reported, without much scrutiny, as support for Melrose from GKN's second largest shareholder.

Actually it's more complicated than that. In fact, Elliott's support for the Melrose bid demonstrates how short-termist this deal is, and the sorts of "investors" that stand to benefit at the expense of GKN workers if it goes ahead.

First up, Elliott Advisers is not actually a GKN "shareholder". If you read the intro to Elliott's statement carefully this is implicitly acknowledged:

Elliott Advisors (UK) Limited, which advises funds (together “Elliott”) that collectively have an economic interest in the shares of GKN plc (“GKN”) representing over 3.4% of its capital

If Elliott Advisers held shares. why not just say they hold over 3.4% of its shares? Because actually they hold derivatives, CFDs by the looks of it. Here's a market disclosure issued on Friday that makes this clear:

So, based on this disclosure, Elliott is not a GKN shareholder, it holds derivatives linked to GKN shares. Indeed it may never have been a shareholder during its two and a half month old economic interest. Elliott could, of course, have chosen to buy shares in the company it says it has a close interest in. Many other investors have done this. Instead apparently Elliott chose derivatives.

Two things flow from this. If Elliott isn't a shareholder, will it get to vote on the bid? I think it probably will, having read a bit around M&A arbitrage. But if so, that presumably means there is a counterparty on the GKN share register that will accept Elliott's voting instructions. This is how the future of the company may be decided.

Secondly, if they are not a shareholder, are they actually party to the bid? The offer is to GKN shareholders, not to holders of derivatives linked to GKN shares. In financial terms Elliott still cashes in of course, because presumably the counterparty passes on the economic return. But I don't think there is a direct transaction between Melrose and Elliott. So Elliot is telling other shareholders to accept an offer for the company that it may not actually be part of (though it will benefit from it).

Another important point did not get raised in press coverage of Elliott's statement yesterday. It has a very large large short position in Melrose - the second largest in the FCA list:

So actually the big investor unveiled as supporting Melrose yesterday is also betting heavily against Melrose shares in the expectation that a successful bid will hit them. Its short position is 1.8%, in the top 10% of shorts by size in the FCA list. So Elliott, despite apparently not being a shareholder in GKN, has a LOT of money on both sides of the deal riding on this bid going ahead.

Finally, Elliott is one of the firms that the ITF identified as using cut and paste copy to explain why they don't comply with the Stewardship Code. The Code was developed to try and increase shareholder responsibility after investors failed to tackle short-termist risky behaviour by banks in the run up to the crisis. Risky short-term behaviour may resonate a bit here.

Despite being willing to take a very public position on the future of a major UK company, which surely falls into 'stewardship' territory, Elliott doesn't seek to comply with the Stewardship Code. Instead it has posted a meaningless bit of copied blurb on its website to get out of it. As a result we put Elliott in the list we sent to the FRC and FCA highlighting cut and paste reporting by hedge funds. We've also suggested that the Code be amended to capture activity around M&A activity.

The fact that Elliott is the only investor with a really sizeable interest - not shareholding - in GKN to have spoken out in favour of Melrose's bid says a great deal. If your most vocal supporter also has one of the largest short positions in your shares it says a lot about who your allies are. And the fact that Elliott has only had an economic interest in GKN since January, and apparently not even a direct shareholding at that, shows you how much of a long-term interest they have.

This is a short-termist bid, backed by short-term speculators playing both sides of the deal. It deserves to fail.

PS - If I have any of the technical info wrong if anyone from Elliott, Melrose or Montfort wants to get in touch I am happy to correct it.

Melrose / GKN bid - is the hedge fund long/short trade unwinding?

As you'll have noticed, I've been following the Melrose bid for GKN with interest. In particular I've been looking at hedge fund activity around the bid, and the short Melrose / long GKN arbitrage trade. As I've blogged previously, one of the key players in this is Davidson Kempner, which at the start of March on its own had a short position of 3.02%. Even last week on the 15th it was at 2.55% according to the FCA's list of disclosed shorts (which shows anything above 0.5%).

The total short positions on the FCA list hit about 13.5% last week, making it (I think) the second most heavily shorted stock in that list. But according to IHS Markit data in this City AM story (which suggests investors are shorting Melrose in the hope the bid fails, which I don't think is right, but hey) the actual total short positions might be over 20%. That's an amazing amount really - about a quarter of Carillion shares were being sold short when it was in real trouble.

Well, today I checked the FCA list and the total of Melrose short positions they report is down to 11.6% (so now about the fourth most shorted stock in the list). And Davidson Kempner is no longer in the list (it's possible it has a position below the 0.5% above which the FCA reports).

When I had a quick look for market disclosures I found that the firm had reduced both its long position in GKN and its short position in Melrose this week. Assuming it had a long position in GKN roughly equivalent to its short in Melrose, this may mark the departure of quite a big investor with a big interest in the bid going ahead.

This is worth keeping an eye on. The total shorts in the FCA list have bumped around a bit, so the departure of one big player may not mean that much, or herald a wider retreat from the long/short trade. But it looks... interesting. I'll have a dig into who else is moving - Sand Grove has built up a big short position for example.

Just a thought, but if you wanted to speculate against the speculators this might be time go long Melrose. If the bid fails while between 10% and 20% of Melrose stock is sold short, and the price starts climbing, there's going to be some hedge funds buying back a lot of shares, quickly.

Melrose / GKN battle continues

Quite a lot of news on the Melrose bid for GKN today.

Unite, which is campaigning strongly against the bid, held a rally and series of meetings at parliament. It is pleasing to see that a lot of Labour MPs are speaking out against the bid too, and it is also attracting scrutiny from the BEIS committee.

As usual, my eye is drawn to what is going on regarding the ownership of the companies involved. On that point, today we've seen two proxy adviser recommendations become public. On the one hand, ISS has come out and given Melrose the thumbs up. According to Reuters, ISS is quite chirpy about it:

“Given the sensible strategic rationale, (Melrose‘s) turnaround track record and reasonable valuation, approval of the acquisition is warranted,” ISS said in a note circulated to clients last week.

On the other, PIRC has come out against the deal:

PIRC has highlighted to investors that Melrose’s decision to go hostile means that it “has not benefited from the co-operation of the GKN board”.
The adviser also said that “significant political and other considerations, including security concerns” have been raised and that Melrose has reported annual losses two years running.

Meanwhile.... speculators gonna speculate. Following up on my last blog, I've been keeping an eye on the total disclosed short position in Melrose. And they've gone up to 11.67%. From a quick skim I think that makes Melrose the 3rd most shorted UK stock in the FCA list currently, after Provident Financial and Debenhams. What is really noticeable is the position held by Davidson Kempner, which has shot up over the past month or so and now stands at 2.46%. Elliott Capital has also built up a position quickly, now at 1.7%. 

I have little doubt that a number of those shorting Melrose are also taking corresponding long positions in GKN. I think the disclosures from the like of HSBC, Bank of America and (more recently) Goldman Sachs probably relate to underlying investors building up an economic interest in GKN, in some cases through derivatives.  

I know M&A arbitrage is a fact of life these days, but it makes me wonder what we should be doing with the takeover rules. I don't believe these sorts of investors have any long-term interest in either GKN or Melrose, they are just trying to skim value off the process of the deal and its likely impact on the values of the shares of each. Yet the deal itself will have an impact - in fact already is having an impact - on the lives of thousands of GKN workers. It seems nuts that we prioritise the interests of the speculators.

Finally, I think there is an important link here with "stewardship". After all, surely one of the genuinely important roles an investor has is influencing the change of ownership of a company. So I thought I'd have a look for Stewardship Code statements for some of investors that are in the mix. 

Here are a few bits from the statement from AQR Capital (which is short Melrose, long GKN) says:

From the introduction 

The Firm uses quantitative tools in a systematic process to build diversified and risk-controlled portfolios. The process does not typically involve subjective assessments of underlying companies or direct contact with the companies in which it invests.  

In relation to principle 3 

AQR’s investment approach, as a quantitative investment manager, is systematic and does not typically involve subjective assessments of underlying companies. AQR’s proprietary quantitative systems analyse various factors, combining them with estimates of transaction costs to arrive at daily investment decisions. All investment decisions are generated by AQR’s quantitative systems, other than in rare instances where the Risk Management Committee deems the circumstances to be exceptional. AQR does not invest in companies with a view to actively intervening in their management. 

I think the firm is pretty straight up about what it does and does not do. What is more, I found the statement very easily.

However I can't find a Stewardship Code statement for Empyrean Capital, and the Davidson Kempner statement (which took some finding) contains some of the cut and paste text to explain non-compliance that I blogged about previously:

The Firm pursues a multi-strategy investment approach, investing in strategies including distressed, event driven and equity long/short, merger arbitrage and convertible/volatility some of which will involve investments in global equities, including UK equities. The Code is therefore relevant to only some aspects of the Firm's trading. While the Firm generally supports the objectives that underlie the Code, the Firm has chosen not to commit to the Code. The Firm invests in a variety of asset classes and in a variety of jurisdictions globally and its approach in relation to the engagement with issuers and their management is therefore determined globally, on a group-wide basis, and will often vary on a case by case basis. That being the case, the Firm does not consider it appropriate to commit to any particular voluntary code of practice relating to any individual jurisdiction or asset class.

In fact the text used by Davidson Kempner is very similar indeed to that used by Elliott:

The Firm pursues a multi-strategy investment approach, including strategies that involve investing in global equities, including UK equities. The Code is therefore only relevant to some aspects of the Firm's trading. While the Firm generally supports the objectives that underlie the Code, the Firm has chosen not to commit to the Code. The Firm invests in a variety of asset classes and in a variety of jurisdictions. The approach/policies of the Firm in relation to engagement with issuers and their management are therefore determined globally, on a group wide basis. The Firm takes a consistent global approach to engagement with issuers and their management in all of the jurisdictions in which it invests and, consequently, does not consider it appropriate to commit to any particular voluntary code of practice relating to any individual jurisdiction.

I guess this is what ownership and stewardship looks like in modern capital markets: generic blurb in regulatory disclosures.

Melrose / GKN bid arbitrage: like flies round...

The Melrose bid for GKN is currently subject to a lot of scrutiny, and is actively being campaigned against by Unite.

What hasn't attracted much scrutiny so far (as far as I am aware) is the extent of speculative activity that is occurring, and as such is affecting the share ownership of both companies involved in the bid. As many people are probably aware, M&A has become quite fertile territory for "event driven" hedge funds, who look to skim off value based on their expectations of how deals usually play out.

Very simply, when there is a bid it is typical for shares in the acquirer to under perform (this could reflect the cost of the acquisition, but perhaps also expectations about how it will play out). On the other side, obviously shares in the target are pushed up when the likely offer is known, but may not totally capture the premium to the pre-bid price because of uncertainty as to whether the bid will be successful. So you will often find some investors are on both sides of the bid - short the acquirer, long the target.

This is happening with Melrose / GKN. The disclosed short interest in Melrose is now over 10%.

To be honest, I've never really followed these trades closely, so I don't know if having 10% of your shares shorted is particularly out of the ordinary. But it does represent a substantial chunk of money that has an interest in the bid going ahead, and being value destructive for Melrose.

Of those that are shorting Melrose, I can already see two investors - AQR and Blackrock - that are also long in GKN (for completeness, Blackrock will also be long Melrose via index funds etc).

Meanwhile, we can also see the impact on the GKN share register. Just in the past few days both Merrill Lynch (Bank of America) and HSBC have disclosed holdings in the company of over 5% (HSBC now has over 6%). When you dig into the detail you can see two things. First, the large majority of this does not NOT relate to traditional asset management (in HSBCs case, it is very clear it is primarily the bank). Secondly, much of the holding in both cases is accounted for by equity swaps.

That means that there are other counter parties out there with an economic interest in the performance of GKN shares, but who have chosen not to (or were not able to) acquire shares. Quite possibly there are counter parties to those swaps that are shorting Melrose. And again we are talking quite a big proportion of GKN's ownership - over 11% - being tied up in these two positions alone.

There are a couple of things that interest me here. First, how do Merrill Lynch and HSBC decide how to respond to the bid? Have they ceded that decision to the counter parties? If so the future of GKN would in part be decided by investors that we can't even see. If not what is the basis of their own decision, and in whose interests is it taken?

Second, it does seem to demonstrate just how far modern capital market activities are away from any notion of "ownership" or "stewardship". A large proportion of the share ownership of both companies is accounted for by investors whose primary interest is in the event of the bid, rather than the future of the companies concerned.