After many years as a mergers and acquisitions and securities lawyer, I began investing in special situations professionally in 1996. Although the strategy has evolved to include any sort of idiosyncratic trade around a specific event or catalyst, then it was basically merger arbitrage.
For the entire period prior to 2000, before such field leveling laws as Sarbanes-Oxley and Regulation FD, a special situations investor could outperform the market by exploiting the informational advantage that came from just researching harder.
But, come the turn of the century, the informational playing field leveled, and many more smart investors and new capital came into all hedge fund strategies eroding significantly the profit making opportunities.
Professional special situations investors expanded their horizons into new trade types (e.g., distressed debt, capital structure arbitrage, etc.) and utilized new asset classes to make their investments. Nevertheless, sustained opportunities to outperform the market became more and more scarce.
Being basically lazy, I wanted to find a new way to invest in special situations that had high barriers to entry that could not simply be eroded by throwing more smart guys and more money at the problem. In 2007, I realized intellectual property-based special situations (IPSS) investing provided that opportunity and I began developing the strategy. Today, IPSS has four sub-components as shown in the graphic below:
Unconstrained L/S: This strategy trades equities long and short opportunistically based on deep intellectual property (IP) value signals without regard portfolio neutrality. Investment returns are derived from fundamental IP portfolio quality analysis and its overall affect on stock performance. Both qualitative and quantitative patent evaluation tools are used.
IP Catalyst Driven Trading: This strategy invests around the catalysts created in (i) distressed investing where strong IP portfolios exist, (ii) IP activist investing where investors are trying to force corporate fundamental change to enhance value of IP portfolios.
We have seen a notable rise in IP-based activist investing opportunities including recently Carl Icahn’s forcing the sale of Motorola Mobility and Starboard Ventures, LP running a hostile proxy contest against MIPS Technologies.
IP-Based Financing: We can extend debt capital based on the value of IP assets. Ocean Tomo’s ability to value IP allows us to be one of the few groups who can lend against intangibles. We can also invest in royalty streams and undertake sale/license-back transactions.
IP Rights Enforcement: For investors with higher risk tolerance and longer term investment horizons, investing in IP enforcement programs can be a great opportunity. Where through effective due diligence one finds infringement, a large addressable market and patent validity, IP Rights Enforcement can provide strong risk adjusted returns.
In subsequent blog posts, we will go into greater detail on the advantages of each strategy and how to trade them in the market today.