CAIA Level I: An Introduction to Core Topics in Alternative Investments, 2nd Edition

CHAPTER 14

Event-Driven Hedge Funds

The event-driven category of hedge funds includes activist hedge funds, distressed securities funds, and merger arbitrage funds, as well as special situation funds and multistrategy funds that combine a variety of event-driven strategies. Event-driven hedge funds speculate on security price movements during the anticipation of and the realization of events. Events include mergers and acquisitions, spin-offs, tracking stocks, accounting write-offs, reorganizations, bankruptcies, share buybacks, special dividends, and any other corporate events that are generally associated with substantial market price reactions in the securities related to the transactions.

The most common transaction for an event-driven strategy fund is to enter positions in one or more corporate securities during a period of event risk. For example, an event-driven strategy fund may purchase the equity of a target firm and short sell the equity in the acquiring firm in a proposed merger and hold those positions until the merger is completed or the deal falls through. The event-driven strategy fund profits when events unfold as predicted by the fund and suffers losses when events unfold with the opposite consequences. In the case of a traditional merger arbitrage transaction, the fund benefits if the specified event such as a merger takes place as proposed and suffers a loss if the merger fails.

14.1 THE SOURCES OF MOST EVENT STRATEGY RETURNS

By their very nature, special events ...