Event-Driven Investing: Making the most of corporate actions and news events

The persistence of mispricing opportunities in the challenges the notion that they are entirely rational and efficiently priced in all material information.

Let's explore strategies for identifying profitable opportunities while managing risks in event-driven .

What are Event-Driven Strategies?

Event-driven strategies aim to profit from temporary stock mispricing before or after corporate actions, like mergers, share buybacks, or dividend announcements. These actions can cause rapid price changes in seconds.

Additionally, these strategies may capitalise on sectors benefiting from government initiatives or increased capital spending, leading to growth for companies and higher shareholder value.

For instance, schemes like Production-Linked Incentives (PLI) in electronics and automobile manufacturing sectors illustrate this approach.

These strategies focus on specific catalysts rather than broad market conditions and typically have a short-term investment horizon.

However, accurately predicting the timing and impact of these events can be challenging, leading to high price volatility within a short timeframe. Additionally, investors must consider transaction costs and taxes.

What are the Different Types of Event-Driven Strategies?

a) Merger and Acquisition Arbitrage: Investors exploit opportunities by capitalising on price differences between the target company's stock and the acquiring company's offer price during mergers and acquisitions.

b) Distressed Investing: Investors seek out financially distressed companies or those undergoing bankruptcy proceedings. They purchase stocks of these companies at low valuations due to financial distress and sell them at higher valuations when the company undergoes a turnaround or a change in management, resulting in improved business operations.

c) Special Situations: Investors target companies involved in legal matters, spinoffs, or divestitures at low valuations and profit from them when these corporate actions are completed.

d) Activist Investing: Investors actively try to influence management decisions to increase shareholder value, leading to profitable opportunities through actions like share buybacks, dividends, or corporate restructuring.

e) Post-Earnings Announcement Drift: Investors identify stocks that exhibit abnormal returns following earnings announcements due to market overreactions or underreactions.

f) Event-Driven Macro Investing: Investors focus on macroeconomic events such as interest rate changes or geopolitical tensions, which can create investment opportunities due to market overreactions or underreactions.

What are the risks in event-driven Strategies?

a) Event outcome uncertainty: The success of event-driven strategies depends heavily on the outcome of the event, and unfavourable outcomes can lead to significant losses.

b) Timing risk: Investors must act swiftly when event-driven strategies unfold, as delays or mistimed actions can result in losses.

c) Liquidity risk: Illiquid securities pose a risk as exiting positions to book profits may be difficult, especially during adverse price movements.

d) Volatility risk: Event-driven strategies are inherently volatile, requiring investors to assess their risk tolerance and make investment decisions accordingly.

e) Competitive landscape: Institutional investors and hedge funds compete using high-frequency trading and algorithmic trading, making it challenging for retail investors to identify mispricing opportunities.

f) Legal and regulatory risk: Event-based investing strategies may involve legal or regulatory risks, particularly if companies are undergoing bankruptcy or facing legal issues.

In summary, event-driven investing strategies offer enticing opportunities but come with risks. Investors need a certain level of predictability and confidence in the outcomes of events to avoid substantial losses.

Note: The article is for information purposes only. This is not investment advice.

(The author is Vice President of Research, TejiMandi)

(Disclaimer: Recommendations, suggestions, views, and opinions given by the experts are their own. These do not represent the views of the Economic Times)