Last updated: 05:57 / Thursday, 28 July 2022
Column by Gabelli Funds

Investment Opportunities After the S&P 500’s Steepest Decline Since 1962

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  • Stocks closed down 16% for the second quarter and dropped 20% for the first half of the year, which was the S&P 500’s steepest total return decline since 1962.  Investors brace for more volatility amid heightened inflation and expected interest-rate increases.
  • M&A activity has remained vibrant as the second quarter of 2022 marked the eighth consecutive quarter that M&A activity exceeded $1 trillion. Excluding SPAC mergers, M&A activity totaled $2.1 trillion, a decline of 14% from the record setting $2.5 trillion in the first half of 2021.
  • We saw a few new issues in May and June, and we are optimistic that issuance will pick up through the second half of the year. In past downturns, the convertible market has been one of the first markets to rebound both from an issuance and performance perspective.

The S&P 500 Index’s powerful post COVID-19 bull market started in March 2020 and more than doubled before it topped out at its all-time high on January 3, 2022.  Stocks closed down 16% for the second quarter and dropped 20% for the first half of the year, which was the S&P 500’s steepest total return decline since 1962.  Investors brace for more volatility amid heightened inflation and expected interest-rate increases. Also, the Russia-Ukraine war and uncertainty associated with future oil production make it more difficult for investors and consumers to navigate in the current inflationary environment.

The Russia-Ukraine war, which now has lasted over four months, has severely impacted global trade, specifically commodity prices. Russia’s invasion of Ukraine prompted Western powers to ban imports of Russian crude and refined products. In addition, the European Union agreed to ban 90% of Russian oil by the end of this year. In an effort to retaliate, Russia has cut off several exports of natural gas to European countries, which creates additional tension to the existing energy supply crunch.

On June 15th, the Federal Reserve announced a 75bp rate hike, the most aggressive rate hike since 1994, in an effort to further combat inflation. Fed Chairman, Jerome Powell, acknowledged the unusually large rate hike but said he does not expect moves of this size to be common. The Fed will continue to monitor inflation and decisions will be made “meeting by meeting”. The market awaits the next FOMC meeting on July 26-27.

M&A activity has remained vibrant as the second quarter of 2022 marked the eighth consecutive quarter that M&A activity exceeded $1 trillion. Excluding SPAC mergers, M&A activity totaled $2.1 trillion, a decline of 14% from the record setting $2.5 trillion in the first half of 2021. The Technology sector was the most active for M&A accounting for a record 25% of dealmaking in the first half, or $530 billion, while Industrials and Financials each accounted for 12%. Private Equity remained highly acquisitive, announcing $553 billion in deals, accounting for a record 26% of all deals in the first half.

Despite spreads widening in June, deals continued to make progress towards closing. Swedish Match (SWMA SS-SEK104.20-Sweden) disclosed they received U.S. antitrust approval to be acquired by Philip Morris International for SEK106 cash per share in a tender that expires at the end of September. Coherent (COHR-$266.22-NASDAQ) and II-VI Inc. received Chinese SAMR approval, which was the final remaining regulatory approval and allowed the deal to close at the end of June. Ultra Electronics (ULE LN-£34.62-London) received provisional approval from the U.K. government to be acquired by Cobham for £35 cash per share, or about £2.5 billion.

Convertibles had another down month as underlying equities lagged and credit spreads continued to widen. With equity markets declining, we have seen premiums expand substantially in some convertibles.  As noted previously, issuance has been a hot topic over the last few years with record issuance levels in 2020 and 2021. The primary market has slowed significantly in 2022 but we have seen a number of companies test the waters with potential deals only to pull them given the market conditions. These companies will still need capital to operate, and the convertible market remains one of the least expensive ways for them to raise that capital. We saw a few new issues in May and June, and we are optimistic that issuance will pick up through the second half of the year. In past downturns, the convertible market has been one of the first markets to rebound both from an issuance and performance perspective. This is because convertibles can be issued quickly and less expensively than traditional bonds or equity. The equity optionality allows investors in these issues to participate in the upside as the market recovers.


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To access our proprietary value investment methodology, and dedicated merger arbitrage portfolio we offer the following UCITS Funds in each discipline:

GAMCO MERGER ARBITRAGE

GAMCO Merger Arbitrage UCITS Fund, launched in October 2011, is an open-end fund incorporated in Luxembourg and compliant with UCITS regulation. The team, dedicated strategy, and record dates back to 1985. The objective of the GAMCO Merger Arbitrage Fund is to achieve long-term capital growth by investing primarily in announced equity merger and acquisition transactions while maintaining a diversified portfolio. The Fund utilizes a highly specialized investment approach designed principally to profit from the successful completion of proposed mergers, takeovers, tender offers, leveraged buyouts and other types of corporate reorganizations. Analyzes and continuously monitors each pending transaction for potential risk, including: regulatory, terms, financing, and shareholder approval.

Merger investments are a highly liquid, non-market correlated, proven and consistent alternative to traditional fixed income and equity securities. Merger returns are dependent on deal spreads. Deal spreads are a function of time, deal risk premium, and interest rates. Returns are thus correlated to interest rate changes over the medium term and not the broader equity market. The prospect of rising rates would imply higher returns on mergers as spreads widen to compensate arbitrageurs. As bond markets decline (interest rates rise), merger returns should improve as capital allocation decisions adjust to the changes in the costs of capital.

Broad Market volatility can lead to widening of spreads in merger positions, coupled with our well-researched merger portfolios, offer the potential for enhanced IRRs through dynamic position sizing. Daily price volatility fluctuations coupled with less proprietary capital (the Volcker rule) in the U.S. have contributed to improving merger spreads and thus, overall returns. Thus our fund is well positioned as a cash substitute or fixed income alternative.

Our objectives are to compound and preserve wealth over time, while remaining non-correlated to the broad global markets. We created our first dedicated merger fund 32 years ago. Since then, our merger performance has grown client assets at an annualized rate of  approximately 10.7% gross and 7.6% net since 1985. Today, we manage assets on behalf of institutional and high net worth clients globally in a variety of fund structures and mandates.

Class I USD - LU0687944552
Class I EUR - LU0687944396
Class A USD - LU0687943745
Class A EUR - LU0687943661
Class R USD - LU1453360825
Class R EUR - LU1453361476

GAMCO ALL CAP VALUE

The GAMCO All Cap Value UCITS Fund launched in May, 2015 utilizes Gabelli’s its proprietary PMV with a Catalyst™ investment methodology, which has been in place since 1977. The Fund seeks absolute returns through event driven value investing. Our methodology centers around fundamental, research-driven, value based investing with a focus on asset values, cash flows and identifiable catalysts to maximize returns independent of market direction. The fund draws on the experience of its global portfolio team and 35+ value research analysts.

GAMCO is an active, bottom-up, value investor, and seeks to achieve real capital appreciation (relative to inflation) over the long term regardless of market cycles. Our value-oriented stock selection process is based on the fundamental investment principles first articulated in 1934 by Graham and Dodd, the founders of modern security analysis, and further augmented by Mario Gabelli in 1977 with his introduction of the concepts of Private Market Value (PMV) with a Catalyst™ into equity analysis. PMV with a Catalyst™ is our unique research methodology that focuses on individual stock selection by identifying firms selling below intrinsic value with a reasonable probability of realizing their PMV’s which we define as the price a strategic or financial acquirer would be willing to pay for the entire enterprise.  The fundamental valuation factors utilized to evaluate securities prior to inclusion/exclusion into the portfolio, our research driven approach views fundamental analysis as a three pronged approach:  free cash flow (earnings before, interest, taxes, depreciation and amortization, or EBITDA, minus the capital expenditures necessary to grow/maintain the business); earnings per share trends; and private market value (PMV), which encompasses on and off balance sheet assets and liabilities. Our team arrives at a PMV valuation by a rigorous assessment of fundamentals from publicly available information and judgement gained from meeting management, covering all size companies globally and our comprehensive, accumulated knowledge of a variety of sectors. We then identify businesses for the portfolio possessing the proper margin of safety and research variables from our deep research universe.

Class I USD - LU1216601648
Class I EUR - LU1216601564
Class A USD - LU1216600913
Class A EUR - LU1216600673
Class R USD - LU1453359900
Class R EUR - LU1453360155

GAMCO CONVERTIBLE SECURITIES

GAMCO Convertible Securities’ objective is to seek to provide current income as well as long term capital appreciation through a total return strategy by investing in a diversified portfolio of global convertible securities.

The Fund leverages the firm’s history of investing in dedicated convertible security portfolios since 1979.

The fund invests in convertible securities, as well as other instruments that have economic characteristics similar to such securities, across global markets (but the fund will not invest in contingent convertible notes). The fund may invest in securities of any market capitalization or credit quality, including up to 100% in below investment grade or unrated securities, and may from time to time invest a significant amount of its assets in securities of smaller companies. Convertible securities may include any suitable convertible instruments such as convertible bonds, convertible notes or convertible preference shares.

By actively managing the fund and investing in convertible securities, the investment manager seeks the opportunity to participate in the capital appreciation of underlying stocks, while at the same time relying on the fixed income aspect of the convertible securities to provide current income and reduced price volatility, which can limit the risk of loss in a down equity market.

Class I USD          LU2264533006

Class I EUR          LU2264532966

Class A USD        LU2264532701

Class A EUR        LU2264532610

Class R USD         LU2264533345

Class R EUR         LU2264533261

Class F USD         LU2264533691

Class F EUR         LU2264533428 

Disclaimer:
The information and any opinions have been obtained from or are based on sources believed to be reliable but accuracy cannot be guaranteed. No responsibility can be accepted for any consequential loss arising from the use of this information. The information is expressed at its date and is issued only to and directed only at those individuals who are permitted to receive such information in accordance with the applicable statutes. In some countries the distribution of this publication may be restricted. It is your responsibility to find out what those restrictions are and observe them.

Some of the statements in this presentation may contain or be based on forward looking statements, forecasts, estimates, projections, targets, or prognosis (“forward looking statements”), which reflect the manager’s current view of future events, economic developments and financial performance. Such forward looking statements are typically indicated by the use of words which express an estimate, expectation, belief, target or forecast. Such forward looking statements are based on an assessment of historical economic data, on the experience and current plans of the investment manager and/or certain advisors of the manager, and on the indicated sources. These forward looking statements contain no representation or warranty of whatever kind that such future events will occur or that they will occur as described herein, or that such results will be achieved by the fund or the investments of the fund, as the occurrence of these events and the results of the fund are subject to various risks and uncertainties. The actual portfolio, and thus results, of the fund may differ substantially from those assumed in the forward looking statements. The manager and its affiliates will not undertake to update or review the forward looking statements contained in this presentation, whether as result of new information or any future event or otherwise.

About Michael Gabelli

Michael Gabelli is a Managing Director at Gabelli & Partners and is based in New York. Gabelli is President of the company, where he is responsible for the business affairs of the Alternative Investment Group, which encompasses hedge funds and UCITS funds. In addition, he serves as Director of Global Business Development for GBL. He also serves as Non-Executive Chairman of Gabelli Japan K.K. Prior to his current position at Gabelli, he served various investment roles on merger arbitrage and value portfolios. Previously, he worked at Bear Stearns in Institutional Equity Research Sales.

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