Most Sanctions Fail

by Thomas Kirchner, CFA

• From substitute for war to forcing domestic policy change.

• Declining success rate of sanctions in the last 25 years.

• Russia sanctions cost West more than Russia.

• World needs a new Vienna Congress.

In 433 BC, Athens barred merchants from neighboring Megara from selling their wares in the Athens market. These earliest recorded sanctions didn't work out too well for the Athenians. The Megarians teamed up with the Spartans to wage the Peloponnesian War, which ended Athens' golden age [I]. The effectiveness of sanctions has not become much better since antiquity. Famously, sanctions on Iraq and Cuba helped Saddam Hussein and Fidel Castro cement their power by allocating scarce imports to their most loyal supporters.

We decided to take a closer look at the Global Sanctions Data Base (GSDB) that is maintained by a team of researchers and spans 1,101 sanctions measures over the period 1950-2019 [ii]. The database does not cover sanctions of the 1920s and 30s, when uncoordinated ad-hoc measures against the axis powers contributed to the collapse of world trade but failed to prevent World War II. After all, following the horrors of World War I, sanctions became the go-to tool for warfare in the 1920s, replacing military conflict through economic warfare. President Woodrow Wilson proclaimed in 1919: “A nation that is boycotted is a nation that is in sight of surrender.” [iii] That, at least, was the idea, which has since become religion. As we will discuss, wrongly so.

The most sanctioned regions will surprise you

The GSDB reveals that, not surprisingly, the countries of North America, Northwestern Europe and Oceania are the least frequently ones targeted by sanctions. Less obvious is that Africa and West Asia are targeted most frequently. Interestingly, most sanctions on African countries are imposed by other African countries. We wonder if much of Africa's regionalism is due to these sanctions. After all, if you want to fly from one African city to another, the only flights available often make you connect through London, Paris or Frankfurt.

Since 1950, the U.S. has been the most frequent sanctioning nation, imposing more than one third of all sanctions worldwide. Under President Obama, the share of all sanctions imposed by the U.S. declined to 30%, in particular after Iran sanctions were lifted in 2016, but rose in the subsequent four years under President Trump to 40%. Trump is said to have been the most active sanctioner of all time, averaging three new measures per day [iv].

From avoiding war to influencing domestic policies

The policy objectives of sanctions have evolved over the years. Sanctions evolved from a substitute for war, as in Wilson's days, to a tool to influence domestic policies in another country. Until 1960, war and territorial conflicts were the principal reasons for sanctions. From the 1970s, human right-related sanctions started to increase, which due to their sharp increase cumulatively represent the largest category since 1950. Democracy is the second-most frequent category. Ending wars is only the 4th most frequent objective for sanctions [iv]. We would assume that this drift toward domestic policy changes also makes sanctions less effective. After all, human rights violations or other objectionable domestic policies are often at the core of a regime's power base. Being sanctioned then is just one of the many costs of staying in power.

Effectiveness

Not surprisingly, the effectiveness of sanctions is hotly contested. Clearly, sanctions labeled “crippling” are imposed with a strong conviction that they will achieve their stated goals. Unfortunately, the data stand in sharp contrast to such overconfident boisterous announcement. Successes are rare. A notable exception are the 1995 sanctions against Peru and Ecuador after border skirmishes along a long-contested area near the Cenepa river had broken out. The sanctions were lifted after both sides consented to the deployment of international observers. However, since this is not a controlled experiment, we can not rule out the possibility that the same outcome would have been had without the imposition of sanctions. Attributing such successes to sanctions might overrate their effectiveness.

Until the mid-1960s, 50% of sanctions in the GSDB are classified as failures, only 20-30% are successes. The situation improved over the following 30 years: by 1995, 50% of all sanctions were considered a complete success. Unfortunately, in the quarter century since 1995, there is a sharp decrease in the success rate. As of 2016, only 20% of sanctions are deemed a complete success, roughly 70% are “ongoing”, which in many cases probably means that nobody wants to admit their failure, so the path of least resistance is to keep them going [iv]. Partly, the decreasing success rate is due to the sharp rise in anti-terrorism sanctions, which we would expect to be of little deterrence on the determination of terror fanatics.

Sanctions against Russia over the Ukraine war

JP Morgan estimates the impact of sanctions on the Russian economy on 11% of GDP and reduced growth in the EU at 2.1% of GDP[v]. This estimate amounts to $165 billion in annual sanction losses for Russia and at least $357 billion for the EU alone, even more if you add non-EU Europe and North America [vi]. As long as JP Morgan's estimates are not completely wrong, the West will suffer more under its own sanctions than Russia. We estimate that only for a contraction of 30% or more will the harm to Russia be worse than for the West. Should gas deliveries to Western Europe be disrupted, then no crash of the Russian economy would be big enough to match the economic devastation of Western Europe.

We can think of other ways how the sanctions are likely to backfire. For example, the ban on exporting technology will only have a short-term impact. We would like to remind readers that the Soviet Union perfected the art of procuring Western technology at the time of the iron curtain. In fact, Soviet microprocessors were copies of Intel and Zilog chips, the export of which to the Warsaw Pact was illegal. We would expect this phenomenon to return as a result of the sanctions. Fake chips from China are already a major problem for the semiconductor industry. If China can manufacture fake chips on a large scale, there is no reason why Russia wouldn't be able to do the same. Such fake chips, which will be much cheaper than the genuine ones, will then find their way into the Western market, where they will only aggravate the scourge of fake chips.

While we certainly wish that sanctions on Russia would end this war quickly, we won't hold our breath. The deck is stacked against their effectiveness. What this conflict needs is a diplomatic solution: a new Vienna Congress.

[i] Camelot calculations based on Bloomberg data.

[ii] Gabriel Felbermayr, Aleksandra Kirilakha, Constantinos Syropoulos, Erdal Yalcin, Yoto V. Yotov: The Global Sanctions Data Base. LeBow College of Business, Drexel University, School of Economics Working Paper Series, WP 2020-02.

[iii] Maxim Trudolyubov: “Sanctions Should Impose Costs Where They Are Due” Wilson Center, September 20, 2020.

[iv] Gabriel Felbermayr, Aleksandra Kirilakha, Constantinos Syropoulos, Erdal Yalcin, Yoto V. Yotov: “The Global Sanctions Data Base: An Update that Includes the Years of the Trump Presidency” LeBow College of Business, Drexel University, School of Economics Working Paper Series, WP 2021-10.

[v] Randall W. Forsyth: “Putin’s War Puts Russia’s Economy—and the World’s—in Its Crosshairs.” Barron's, March 2, 2022.

[vi] Camelot calculations based on World Bank data.

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Thomas Kirchner, CFA, has been responsible for the day-to-day management of the Camelot Event Driven Fund (EVDIX, EVDAX) since its 2003 inception. Prior to joining Camelot he was the founder of Pennsylvania Avenue Advisers LLC and the portfolio manager of the Pennsylvania Avenue Event-Driven Fund. He is the author of 'Merger Arbitrage; How To Profit From Global Event Driven Arbitrage.' (Wiley Finance, 2nd ed 2016) and has earned the right to use the CFA designation.

Camelot Event-Driven Advisors LLC | 1700 Woodlands Drive | Maumee, OH 43537 // B340

Disclosures:
• Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy (including the investments and/or investment strategies recommended by the adviser), will be profitable or equal to past performance levels.
• This material is intended to be educational in nature, and not as a recommendation of any particular strategy, approach, product or concept for any particular advisor or client. These materials are not intended as any form of substitute for individualized investment advice. The discussion is general in nature, and therefore not intended to recommend or endorse any asset class, security, or technical aspect of any security for the purpose of allowing a reader to use the approach on their own. Before participating in any investment program or making any investment, clients as well as all other readers are encouraged to consult with their own professional advisers, including investment advisers and tax advisors. Camelot Event Driven Advisors can assist in determining a suitable investment approach for a given individual, which may or may not closely resemble the strategies outlined herein.
• Some information in this presentation is gleaned from third party sources, and while believed to be reliable, is not independently verified.
• Camelot Event-Driven Advisors, LLC, is registered as an investment adviser with the United States Securities and Exchange Commission. Registration as an investment adviser does not imply any certain degree of skill or training. Camelot Event-Driven Advisors, LLC’s disclosure document, ADV Firm Brochure is available at http://adviserinfo.sec.gov/firm/summary/291798

Copyright © 2021 Camelot Event-Driven Advisors, All rights reserved

Tech Crash: what's Next?

by Thomas Kirchner, CFA

• Unprofitable tech to continue sliding.

• Bright spots in Chinese tech.

• Many SPAC’s will soon trade below cash.

Last week's short-lived tech rally pushed some unprofitable tech stocks up nearly 50%. As remarkable as such a move is, strong temporary moves to the upside are nothing unusual in a market that is crashing. And “crash” is the best description of what some areas of the technology sector are going through.

Tech stocks, as measured by NASDAQ, peaked on November 19, 2021. However, if we look at the subset of unprofitable growth stocks, former unicorns that have seen tremendous growth in their stock prices in recent years or former SPACs, then the peak in many of these stocks occurred a few months earlier shortly after the meme stock mania. Chinese tech stocks, in turn, peaked in late 2020 as the Chinese government clampdown on tech companies began. [i]

Profitable vs. unprofitable tech

The distinction between profitable and unprofitable tech appears to have been a big driver of the performance differential since last year's peak, and we believe this will become even more critical during the next two years.

For some firms, Covid has been an accelerator that brought long-term technology adoption forward. For others, it represented a one-time boost. For most tech companies, it seems to have been a combination of both: technology adoption was accelerated by Covid well above the long-term trend. With the return to normal, we expect to see a pullback toward the trendline. The exuberant enthusiasm for profitable stay-at-home-stocks has since turned into a hangover, with many of these firms giving back much of their multiple expansions. While the worst valuation excesses in some of these stocks have since been rectified by the market, we still would avoid these former market darlings.

Unprofitable tech firms have become an asset class of their own. Similarities to the dot-com boom of the late 1990s abound with a singular focus on growth and questionable business models. Even companies in the gig economy, and even real estate subletting firms have been classified as “tech” on the mere basis that these firms have an app as an interface with their customer. Many of these business models are, in our view, unsustainable.

For example, food delivery should be a straightforward cash business. Yet, not a single food delivery company we are aware of is profitable, even though employees often are not even earning minimum wage. The same applies to ride hailing apps, the other part of the gig economy that benefits from large valuations. These companies failed to turn a profit for years while growing. This would be plausible if newly acquired business takes time to become profitable. However, they still fail to become profitable when growth slows, and they should be able to harvest cash flow. The absence of such profits has us conclude that it is simply not possible to run many businesses in the gig economy profitably.

Chinese tech

We asked in December if Chinese tech stocks have bottomed. As we pointed out at the time, the clampdown on Chinese tech firms was caused by the power struggle in the CCP between President Xi's clan, which advocates traditional authoritarian communism with limited market elements, and supporters of former Premier Jiang Zemin, who advocate further free-market reforms, a group that includes many tech entrepreneurs. It appeared at the time that Xi had consolidated his power to a point where a third term at the Congress in September was a given. However, after the Olympics turned out to be less of a PR success than anticipated for President Xi, it is not surprising that a new wave of power consolidation hits Chinese tech stocks with reports of a new attack on Ant Financial, whose shelved IPO was the beginning of the clampdown in November 2020, and ride-hailing app Didi.

It appears that the vigor of the adverse market reaction to the renewed tech clampdown took Chinese authorities by surprise. This explains Chinese officials' comments, led by Vice-Premier Liu He last Wednesday, that authorities need to take a “standardized, transparent and predictable” approach to regulation [ii]. We believe that regulatory risks to Chinese tech stocks are now minimal because further attempts to consolidate power at the expense of financial markets would backfire and put the wisdom of the party's leadership in question.

The main risk to Chinese tech stocks listed in the U.S, now comes from Washington and the potential for delisting. This can play out in two ways: Chinese tech companies delisted in the U.S. could simply relist in Hong Kong, as Didi plans to do. An OTC market for ADRs may develop in the U.S. The other option would be a going private transaction at a low valuation followed by a relisting in Hong Kong. With the sharp correction in the Hang Seng tech index, this has become less attractive unless the discount that can be had by the buyout group in U.S. markets becomes extreme. In such a scenario, we expect investors to exercise dissenters' rights en masse.

SPAC crash

612 SPACs are currently looking for targets to take public through reverse mergers [iii]. This compares to about 4,000 companies currently traded publicly in the U.S. If each SPAC were successful, the number of publicly traded companies would expand by nearly 15% within the next two years after having declined from 5,500 in the 20 years from 2000 to 2020 [iv]. We expect that a large number of SPACs will liquidate without a merger, which will result in the sponsors losing their investment. Sponsor capital will provide the yield on investor cash held in the SPAC's trust account. We estimate the potential transfer of sponsor equity to public SPAC investors at up to $3bn [v].

The desperation of SPAC sponsors to get a deal done so that they do not lose their investment shows itself in the large number of questionable businesses models that SPACs have taken public.

Too many former SPACs fall into the category of lossmaking tech companies. Without the ability to raise new capital, their market value will eventually fall below the cash on their balance sheet, while they burn through cash. We anticipate seeing a re-run of the early 2000s, when activists acquired controlling stakes in these fallen angels at steep discounts to cash on the balance sheet, took control of the board and then simply liquidated the firms and distributed the cash. For many investors, that was the best outcome compared to letting the companies burn through the remaining cash.

The tech crash offers interesting opportunities for shrewd investors, even on the long side. As always, caveat emptor.

[i] Camelot calculations based on Bloomberg data.
[ii] “China stocks leap after State Council pledges support for economy, capital markets.” Reuters, March 16, 2022.
[iii] spacinsider.com/stats/ retrieved on 3/21/22.
[iv] Vartika Gupta, Tim Koller, Peter Stumpner: “Reports of corporates’ demise have been greatly exaggerated.” McKinsey Insights, McKinsey & Company, October 21, 2021.
[v] Camelot calculations.

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Thomas Kirchner, CFA, has been responsible for the day-to-day management of the Camelot Event Driven Fund (EVDIX, EVDAX) since its 2003 inception. Prior to joining Camelot he was the founder of Pennsylvania Avenue Advisers LLC and the portfolio manager of the Pennsylvania Avenue Event-Driven Fund. He is the author of 'Merger Arbitrage; How To Profit From Global Event Driven Arbitrage.' (Wiley Finance, 2nd ed 2016) and has earned the right to use the CFA designation.

Camelot Event-Driven Advisors LLC | 1700 Woodlands Drive | Maumee, OH 43537 // B336

Disclosures:
• Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy (including the investments and/or investment strategies recommended by the adviser), will be profitable or equal to past performance levels.
• This material is intended to be educational in nature, and not as a recommendation of any particular strategy, approach, product or concept for any particular advisor or client. These materials are not intended as any form of substitute for individualized investment advice. The discussion is general in nature, and therefore not intended to recommend or endorse any asset class, security, or technical aspect of any security for the purpose of allowing a reader to use the approach on their own. Before participating in any investment program or making any investment, clients as well as all other readers are encouraged to consult with their own professional advisers, including investment advisers and tax advisors. Camelot Event Driven Advisors can assist in determining a suitable investment approach for a given individual, which may or may not closely resemble the strategies outlined herein.
• Some information in this presentation is gleaned from third party sources, and while believed to be reliable, is not independently verified.
• Camelot Event-Driven Advisors, LLC, is registered as an investment adviser with the United States Securities and Exchange Commission. Registration as an investment adviser does not imply any certain degree of skill or training. Camelot Event-Driven Advisors, LLC’s disclosure document, ADV Firm Brochure is available at http://adviserinfo.sec.gov/firm/summary/291798

Copyright © 2021 Camelot Event-Driven Advisors, All rights reserved.

War in Ukraine: Risk of Systemic Shock

by Paul Hoffmeister, Chief Economist

• Since February 1, the S&P 500 is down over 4%, gold up more than 9%, and oil up over 20%, according to Bloomberg.

• Ukrainian President Zelensky is demanding that NATO impose a no-fly zone over his country, warning that “all the people who die from this day forward will die because of you”. On Saturday, March 5, Vladimir Putin warned the West, “Any movement in this direction will be considered by us as participation in an armed conflict by that country.”

• The potential exists of a systemic shock to the global economy if financial intermediation becomes paralyzed due to the economic and financial consequences of the conflict.

After weeks of tension, Vladimir Putin invaded Ukraine on February 24, and in addition to the human toll, the financial consequences have been stark. According to Bloomberg, since February 1, the S&P 500 is down over 4%, gold up more than 9%, and oil up over 20%.

As gold is arguably a useful reflector of geopoltical developments, the above gold chart illustrates the correlation between the evolution of recent Ukraine events and ultimately market prices, such as gold.

On December 17, Russia published draft security pacts for the US and NATO. Included in its demands to the West were denying NATO memberships to Ukraine and other post-Soviet countries, rolling back troops and weapons in central and eastern Europe, and other limits on Western military activities near Russia. The US and NATO responded in writing on January 26.[i] In a brief moment of hope, Secretary of State Blinken called the response a “serious diplomatic path” to resolving the dispute. But, shortly thereafter, Russian Foreign Minister Lavrov said that he saw “no positive reaction” to Russia’s demands, which echoed Kremlin spokesman Dmitry Peskov, who said that the West’s responses were “not much cause for optimism”.

After weeks of growing tensions and a Russian buildup of troops along the Ukrainian border, President Putin issued a presidential decree on February 21 recognizing the independence of the Luhansk and Donetsk republics, which have deep ties to Russia and where the majority of the populations’ first language is Russian.”[ii] The next day, Russia’s parliament, the Duma, authorized the use of force in Ukraine. Two days later, on February 24, the invasion of Ukraine began.

Thus far, the military assault is focused in the eastern Ukrainian provinces and near Kiev, and the United Nations reports that nearly 1.5 million Ukrainians have been displaced. In the coming days, Russia and Ukraine will continue talks, but not many are optimistic.

President Zelensky is demanding that NATO impose a no-fly zone over his country, warning that “all the people who die from this day forward will die because of you”.[iii] On Saturday, March 5, President Putin warned the West, “Any movement in this direction will be considered by us as participation in an armed conflict by that country.”

The geopolitical risks today cannot be understated, and could quickly push the United States and Russia into a standoff not seen since the Cuban Missile Crisis. For investors, the important variables to monitor in the coming days and weeks is the extent to which the West will “participate” in fighting in Ukraine, and the risk of a direct conflagration between US/NATO and Russian troops.

In addition to the risk of an expanded fight – particularly between the West and Russia -- there is a major risk to global financial conditions. It’s possible that the economic toll and sanctions could have a knock-on effect on the banking system and the flow of credit.

For example, the Biden Administration and the European Union issued its first round of sanctions on February 22, which were aimed at two Russian banks, Russian sovereign debt, and certain individuals.[iv] Then, by the weekend of February 26-27, the European Commission revealed that it was considering sanctions that it could target up to 70% of the Russian banking industry. On February 28, the ECB announced that the European subsidiary of Sberbank Europe AG and two subsidiaries were failing or likely to fail due to a deterioration in their liquidity situation.[v] The next day, European regulators announced that the Sberbank AG would enter insolvency proceedings.

This news of Sberbank’s European subsidiary failing correlated with the relatively sudden and significant widening in credit spreads, suggesting a sudden panic in global liquidity conditions. Specifically, the Moody’s Baa-Aaa credit spread widened from 73 basis points on February 22 to 91 basis points on February 28.

[i] “U.S. Responds to Russia Security Demands as Ukraine Tensions Mount”, by Humeyra Pamuk and Dmitry Antonov, January 26, 2022, Reuters.
[ii] “Putin Recognizes Independence of Ukraine Breakaway Regions”, February 21, 2022, Al Jazeera.
[iii] “Ukraine no-fly zone would mean participation in conflict: Putin”, March 5, 2022, Al Jazeera.
[iv] U.S. and Allies Impose Sanctions on Russia as Biden Condemns ‘Invasion’ of Ukraine”, by Michael Shear, Richard Perez-Pena, Zolan Kanno-Youngs, and Anton Troianovski, February 22, 2022, New York Times.
[v] “Austria-based Russian Bank Declared Insolvent Due to Sanctions”, March 4, 2022, The Local.

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Paul Hoffmeister is chief economist and portfolio manager at Camelot Portfolios, managing partner of Camelot Event-Driven Advisors, and co-portfolio manager of the Camelot Event-Driven Fund (tickers: EVDIX, EVDAX).

Camelot Event-Driven Advisors LLC | 1700 Woodlands Drive | Maumee, OH 43537

Disclosures:
• Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy (including the investments and/or investment strategies recommended by the adviser), will be profitable or equal to past performance levels.
• This material is intended to be educational in nature, and not as a recommendation of any particular strategy, approach, product or concept for any particular advisor or client. These materials are not intended as any form of substitute for individualized investment advice. The discussion is general in nature, and therefore not intended to recommend or endorse any asset class, security, or technical aspect of any security for the purpose of allowing a reader to use the approach on their own. Before participating in any investment program or making any investment, clients as well as all other readers are encouraged to consult with their own professional advisers, including investment advisers and tax advisors. Camelot Event Driven Advisors can assist in determining a suitable investment approach for a given individual, which may or may not closely resemble the strategies outlined herein.
• Any charts, graphs, or visual aids presented herein are intended to demonstrate concepts more fully discussed in the text of this brochure, and which cannot be fully explained without the assistance of a professional from Camelot Portfolios LLC. Readers should not in any way interpret these visual aids as a device with which to ascertain investment decisions or an investment approach. Only your professional adviser should interpret this information.
• Some information in this presentation is gleaned from third party sources, and while believed to be reliable, is not independently verified.
• Camelot Event-Driven Advisors, LLC, is registered as an investment adviser with the United States Securities and Exchange Commission. Registration as an investment adviser does not imply any certain degree of skill or training. Camelot Event-Driven Advisors, LLC’s disclosure document, ADV Firm Brochure is available at http://adviserinfo.sec.gov/firm/summary/291798

Copyright © 2021 Camelot Event-Driven Advisors, All rights reserved. B333

Exploding Rate Expectations; Ukraine Risk

by Paul Hoffmeister, Chief Economist

• Expectations of rate hikes this year have exploded higher.

• Correlates with the jump in statistical inflation to a new, higher range since October.

• Russia to pursue largest military land operation since 1945?

• While Russia annexed Crimea in February-March 2014, gold prices jumped more than 10%.

Expectations of how much the Federal Reserve is going to raise interest rates this year have exploded higher. According to the Chicago Board of Trade, the December 2022 fed funds future is suggesting that the federal funds rate, which now trades around 8 basis points, will be nearly 137 basis points in December. This implies that the FOMC will raise the overnight lending rate by a quarter point at least 5 times in the coming months.

What’s especially notable about these expectations is how quickly they’ve changed during the last three months. In early October 2021, the December 2022 fed funds future indicated that the market was only 1 quarter point increase this year.

What’s behind this major shift? In our view, it’s partly due to the recovering economy following the global shutdown in Q2 2020. Prior to the pandemic, according to the Bureau of Labor Statistics, the U.S. unemployment rate was 3.5%; today, it’s 4.0%. But even more, statistical inflation began to break out in October 2021. Specifically, the core Personal Consumption Expenditures Index according to the Bureau of Economic Analysis began to rise from a 3.6% year-over-year increase to 4.9% today.

Since the breakout of inflation in October to a new, higher range, the Federal Reserve has communicated a series of hawkish policy changes ahead. For example, on November 3, the FOMC announced that it would reduce the pace of bond purchases, which suggested that its quantitative easing program would end by mid-2022. On November 30, Chairman Powell acknowledged that “it’s probably a good time to retire [the word transitory] and the bond taper may need to conclude a “few months sooner”. On December 15, the FOMC announced the plan to conclude its bond buying program in March. Then, on January 26, the FOMC statement read: “With inflation well above 2 percent and a strong labor market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate.”

A rate increase in March, following the FOMC’s March 15-16 meeting, seems to many to be a fait accompli. Underscoring the speed in which expectations have changed recently, the prospect of a March increase was highly unlikely based how fed funds futures were trading last October.

Ukraine: Senior U.S. military and state department officials briefed the House and Senate in closed door meetings last Thursday. According to the New York Times, lawmakers were informed that Russia has assembled 70% of the forces necessary to mount a full-scale invasion of Ukraine, which “would constitute the largest military operation on land in Europe since 1945.” Some officials believe that were Russia to invade, it would not occur until the second half of February, so as not to antagonize China’s leadership, who will be overseeing the Winter Olympics in Beijing. Furthermore, it would allow the ground to freeze even more, making it easier to move heavy equipment and vehicles. Officials outlined 5 provocative scenarios that President Putin could undertake in Ukraine, from a coup or limited incursion to a larger scale invasion to take over most of the country.[i]

President Biden has ordered 3000 troops to Eastern Europe in countries bordering Ukraine, but he insists they will not go into Ukraine.[ii] And, according to the New York Times, American and European officials have warned of “sanctions on Russia’s banks, trade restrictions on semiconductors and other high-tech items and the freezing of the accounts of Russian oligarchs and leaders.”

What does this mean for investors? We don’t believe this issue will be resolved anytime soon and will likely linger for a long time. Furthermore, geopolitical variables can be enormously complex and unpredictable, and similar periods of time can be useful for investors to navigate markets amid uncertain variables like these. When Russia annexed Crimea in 2014, the S&P 500 returned over 5% between in February and March, but we’d emphasize that stocks were then coming off a very weak January. Additionally, gold prices jumped from approximately $1250 in early February 2014 to more than $1380 in March 2014.

[i] “US warns of grim toll if Putin pursues full invasion of Ukraine,” by Helene Cooper and David Sanger, February 5, 2022, New York Times.
[ii] “Biden moving US troops in Eastern Europe won’t prevent Russian invasion, experts agree,” by Caitlin McFall, February 5, 2022, Fox News.

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Paul Hoffmeister is chief economist and portfolio manager at Camelot Portfolios, managing partner of Camelot Event-Driven Advisors, and co-portfolio manager of the Camelot Event-Driven Fund (tickers: EVDIX, EVDAX).

Camelot Event-Driven Advisors LLC | 1700 Woodlands Drive | Maumee, OH 43537 // B313

Disclosures:
• Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy (including the investments and/or investment strategies recommended by the adviser), will be profitable or equal to past performance levels.
• This material is intended to be educational in nature, and not as a recommendation of any particular strategy, approach, product or concept for any particular advisor or client. These materials are not intended as any form of substitute for individualized investment advice. The discussion is general in nature, and therefore not intended to recommend or endorse any asset class, security, or technical aspect of any security for the purpose of allowing a reader to use the approach on their own. Before participating in any investment program or making any investment, clients as well as all other readers are encouraged to consult with their own professional advisers, including investment advisers and tax advisors. Camelot Event Driven Advisors can assist in determining a suitable investment approach for a given individual, which may or may not closely resemble the strategies outlined herein.
• Any charts, graphs, or visual aids presented herein are intended to demonstrate concepts more fully discussed in the text of this brochure, and which cannot be fully explained without the assistance of a professional from Camelot Portfolios LLC. Readers should not in any way interpret these visual aids as a device with which to ascertain investment decisions or an investment approach. Only your professional adviser should interpret this information.
• Some information in this presentation is gleaned from third party sources, and while believed to be reliable, is not independently verified.
• Camelot Event-Driven Advisors, LLC, is registered as an investment adviser with the United States Securities and Exchange Commission. Registration as an investment adviser does not imply any certain degree of skill or training. Camelot Event-Driven Advisors, LLC’s disclosure document, ADV Firm Brochure is available at http://adviserinfo.sec.gov/firm/summary/291798

Copyright © 2021 Camelot Event-Driven Advisors, All rights reserved.

Will Rate Hikes Break the M&A Boom?

by Thomas Kirchner, CFA

• 70% of mergers are all cash.

• Large cash hoards reduce need for debt financing.

• Regulations bigger concern than interest rates.

2021 set a new record of M&A activity, with global volumes reaching $5.1 trillion and U.S. mergers increasing 50% to $2.5 trillion from the prior year. Volumes in Europe and Asia continue to lag U.S. activity with $1.5 and $1 trillion, respectively . So far in 2022, the year is off to a strong start thanks to Microsoft's deal to buy Activision for $75 billion, which will make it one of the 10 largest U.S. mergers of all time. As always, the numbers are skewed heavily by a small number of mega mergers. Only 64 deals had over $10 billion in size, representing 0.4% of the number of mergers. However, these 64 mergers represented 24% of deal volume by dollars. [i]

SPACs flame out

SPACs contributed about 10% to global M&A volume and thus constitute a significant portion of the total. Of the 199 SPAC mergers completed last year, only 15 shares trade in positive territory. Only 8 have outperformed the S&P 500 [ii]. This performance is in line with past experience. As we wrote previously, the long-term performance of SPAC mergers is poor. Their poor performance was foreseeable when we wrote this in April 2021. SPACs are best viewed as a poor substitute for venture capital, where most investments result in a complete loss, with only a small fraction providing strong returns. Venture capital funds are successful only if the small minority of winners has such a phenomenal performance that it more than offsets the losers. Given these challenges, it is not surprising that despite all the hype, only the top quartile of venture capital funds beats the S&P 500 [iii].

Regulation is back

After four years of generally lax anti-trust enforcement – although the final years of the Obama administration also were not particularly tough – merger regulation is back. The appointment of Lina Khan as head of the FTC signals the implementation of President Biden's “whole-of-government” approach to regulation. The traditional anti-trust analysis involving consumer welfare is replaced by a broader review of the impact of mergers on the environment, labor and equality. These extra layers of bureaucracy will prolong the timeline of larger mergers.

A plethora of new regulations will, in the aggregate, impact merger activity negatively even though each new rule, taken in isolation, is not a big deal. For example, early terminations of the HSR waiting period will no longer be granted. It used to be standard practice that when the DOJ or FTC determined that a merger had no anti-competitive threat, they would let the merger go ahead immediately by terminating the statutory HSR waiting period early. This will no longer be done. Of course, this makes no sense: the regulators have determined that a merger poses no anti-competitive threat, yet it cannot go ahead until a pre-determined waiting period has expired, during which nothing is done. Clearly, this measure is more political messaging than tough regulation. It certainly is not smart regulation.

Similarly, the government now has the ability to extend merger review processes indefinitely. The underlying philosophy of anti-trust regulation was to minimize disruption to business activity by forcing regulators to act quickly or, if they can't get their act together promptly, drop merger challenges. The FTC is now keeping investigations open beyond the usual time periods and warns merger parties that if they go ahead and close a deal, they do so at their own risk.

Cash is king

70% of all mergers (by size) last year were all cash, only 9% were all stock, with the remainder having a combination of cash and stock [I]. With credit spreads still low by historical standards and corporate cash balances at all time records, we expect cash to continue to be the preferred form of M&A payment for the foreseeable future.

Moreover, private equity funds are sitting on over $1 trillion in dry powder [iv]. This committed capital needs to be put to work irrespective of the level of interest rates.

While rising interest rates will make cost of debt financing more expensive, the enormous aggregate amount of cash available means that buyers, on average, can reduce the amount of debt financing employed in M&A and simply use more cash when the cost of debt becomes too high.

Therefore, we do not believe that rising interest rates directly will impact M&A volumes. However, there is an indirect risk: should financing become unavailable due to higher rates – for example, if banks were to tighten lending standards or regulators were to clamp down on leveraged acquisitions – then an indirect impact would be sharply reduced M&A activity. We have last seen such an outlier in the 2008 credit crunch. However, for a credit crunch to occur, you need major components of the financial system to implode. Therefore, we highly doubt that a sharp reduction of M&A activity is on the horizon. A bigger concern than interest rates is the increase in regulation and enforcement, which quite clearly is designed to reduce M&A activity. U.S. business has benefited from large improvements in efficiency over the last 20 years, some of which was driven by the cost cutting that follows when duplicate overhead is eliminated as a result of M&A. If the government regulates such efficiency gains away, it will have negative long-term consequences for the economy overall.

[i] Camelot calculations based on Bloomberg data.
[i] Nikou Asgari, Patrick Mathurin and Chris Campbell: “Spac wizards run out of magic as returns prove weak” Financial TImes, January 22, 2022.
[iii] David Siegel: “Ventureball: A Primer on Venture Capital for Hedge-Fund Investors.” Data Driven Investor, January 15, 2020. However, we would like to point out that while the statistic about the top quartile is quoted frequently, there is a strong debate about its accuracy.
[iv] Kaye Wiggins: “Cash-rich private equity pays record premiums to snap up public companies” Financial Times, October 7, 2021.

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Thomas Kirchner, CFA, has been responsible for the day-to-day management of the Camelot Event Driven Fund (EVDIX, EVDAX) since its 2003 inception. Prior to joining Camelot he was the founder of Pennsylvania Avenue Advisers LLC and the portfolio manager of the Pennsylvania Avenue Event-Driven Fund. He is the author of 'Merger Arbitrage; How To Profit From Global Event Driven Arbitrage.' (Wiley Finance, 2nd ed 2016) and has earned the right to use the CFA designation.

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