Can Event Driven ETFs Work?

A look at one aspect of hedge fund replication; event driven funds.

JP Morgan just launched an event driven hedge fund replicator that trades with symbol JPED. I am always eager to learn about these types of funds when they hit the market. I am a huge believer in small positions in diversifiers, including hedge fund replication, to help smooth out the ride during market downturns. I have made this point a few times already here at theMaven but I believe these exposures to be vital when used correctly and in small doses.

Event driven refers to “event-driven investing is a hedge fund investment strategy that seeks to exploit pricing inefficiencies that may occur before or after a corporate event, such as an earnings call, bankruptcy, merger, acquisition, or spinoff,” so says Wikipedia. Investopedia provides a little more color;

When a hedge fund manager or other event-driven strategist finds a potential investment, he or she will examine the underlying value of the company and the situation surrounding the event, including potential regulatory pitfalls. If he or she feels positive about the event and the strength of the company, he or she may buy shares to sell later when the price adjusts.

To look at the JPED holdings you will see a listing of individual stocks held long and short and even if you can’t necessarily figure out what the events the fund is targeting, the framework seems to make general sense.

But that is something that fund holders might have to live with, not knowing what events are being isolated. For example, the fund owns Qualcomm (QCOM). Qualcomm has a lot going on these days and it is not clear whether the fund owns it because it is trying to buy NXP Semiconductor (NXPI) which is also a long position in the fund or if it owns QCOM because Broadcom (AVGO) is trying to buy QCOM but AVGO is not in the fund. Maybe it owns QCOM for something tied to back and forth lawsuits with Apple (AAPL) or some other lawsuit. That might make for a difficult hold, especially for an adviser buying for clients.

“Tell me about this JPED fund you bought me.”

“I can’t.”

That’s not such a great conversation. The fund might do exactly what is hoped for in terms of delivering a hedged-like result but having just launched, there is no way to know. Arguably there is no way to analyze the fund, buying it might just be an expression of faith that JP Morgan can do what it says it can.

The IndexIQ Hedge Event Driven Tracker (QED) has been around for a while but takes a much different approach as a fund of funds. The largest holding is Vanguard Short Term Corporate Bond ETF (VCSH) with a 29% weighting followed by 25% in SPDR Convertible Bond ETF (CWB) and 18% in PowerShares Senior Loan ETF (BKLN). Despite the top three accounting for 73% of the fund, QED actually has many more positions than just three.

As I look at QED I can’t figure how it captures an event driven strategy. Like JPED, there is no easy way to analyze the fund other than as a fixed income proxy. With almost ¾ of the fund in those three fixed funds (there’s more than three in there) I would expect it to trade more like a fixed income proxy but that doesn’t have to be a negative. However, if it is a fixed income proxy by virtue of owning a lot of fixed income ETFs then I might want it to have something of a yield but the 0.99% total annual fund operating expense means there isn’t a lot left over for yield. QED is an annual pay, last year’s was 2.3% and it looks like it is too early to know what this year’s payout will be.

That being said, QED’s results have been good. ETF.com has the one-year number at a plus 9.23% for the index. The fund is tiny and so the trading is light. JPED charges 0.85% and has $25 million in AUM.

Despite both funds targeting event driven hedge fund replication they obviously take much different routes there. It would be difficult to think the results of the two would be similar once JPED has a track record, but we will see. Despite some warts with QED it appears to deliver a decent result with little volatility and a reasonably low correlation to equities.