Merger arbitrage investing strategies

If a deal falls apart, the arbitrageur typically suffers significant losses as the target shares fall precipitously to a price that no longer reflects a takeover premium. Over the past 15 years, merger arbitrage has been competitive with bonds, with the Eurekahedge Arbitrage Index beating the Bloomberg Barclays Aggregate Bond Index by about 0. Since , this risk premium has averaged about 3. While merger arbitrage has historically exhibited a low correlation to both treasuries and the broad-based bond index, it has provided low-volatility returns similar to these fixed income strategies and the returns have been positive most years.

However, given the resource and time-intensive nature of the strategy, along with the need to have a well-diversified portfolio of arbitrage investments, individual investors who cannot dedicate themselves full-time to the strategy should steer clear of merger arbitrage and seek to allocate to an arbitrage fund run by a professional. And investors need to eat.

The opinions expressed in this document do not necessarily represent the views of Accelerate Financial Technologies Inc. This article does not constitute investment, legal or tax advice. Any data provided in this article should not be viewed as a recommendation or solicitation of an offer to buy or sell any securities or investment strategies. The information in this article is based on current market conditions and may fluctuate and change in the future. No representation or warranty, expressed or implied, is made on behalf of Accelerate as to the accuracy or completeness of the information contained herein.

Accelerate does not accept any liability for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on all or any part of this article and any liability is expressly disclaimed. Accelerate may have positions in securities mentioned. Past performance is not indicative of future results. LinkedIn David Kindness is a Certified Public Accountant CPA and an expert in the fields of financial accounting, corporate and individual tax planning and preparation, and investing and retirement planning.

David has helped thousands of clients improve their accounting and financial systems, create budgets, and minimize their taxes. Merger arbitrage, often considered a hedge fund strategy, involves simultaneously purchasing and selling the respective stock of two merging companies to create "riskless" profits. Because there is the uncertainty of the deal being completed, the stock price of the target company typically sells at a price below the acquisition price. A merger arbitrageur will review the probability of a merger not closing on time or at all and will then purchase the stock before the acquisition, expecting to make a profit when the merger or acquisition completes.

Key Takeaways Merger arbitrage is an investment strategy whereby an investor simultaneously purchases the stock of merging companies. A merger arbitrage takes advantage of market inefficiencies surrounding mergers and acquisitions. Merger arbitrage, also known as risk arbitrage, is a subset of event-driven investing or trading, which involves exploiting market inefficiencies before or after a merger or acquisition.

Understanding Merger Arbitrage Merger arbitrage, also known as risk arbitrage, is a subset of event-driven investing or trading, which involves exploiting market inefficiencies before or after a merger or acquisition. A regular portfolio manager often focuses on the profitability of the merged entity.

By contrast, merger arbitrageurs focus on the probability of the deal being approved and how long it will take to finalize the deal. Since there is a probability the deal may not be approved, merger arbitrage carries some risk. Merger arbitrage is a strategy that focuses on the merger event rather than the overall performance of the stock market.

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The yield generated from a diversified portfolio of merger arbitrage investments is analogous to that of a high-yield bond portfolio. One of the most important considerations when making an investment is how much an investor is expected to earn. The standard deviation of an investment strategy refers to its volatility or general riskiness. It indicates how much the value of the investment will swing from its average.

From to , merger arbitrage produced the highest risk-adjusted return amongst various asset classes, clocking in higher returns with lower volatility than both global stocks and global bonds. For those 11 years, merger arbitrage returned 4. Merger arbitrage has been one of the most consistent and stable investment strategies. Since , it was one of the only strategies that produced positive returns each calendar year.

The global bond portfolio suffered three down years over this time period. Historically, the average arbitrage spread above cash has been about 3 or 4 percent. Mergers generally close relatively quickly. The current average duration of deals is approximately 3 months.

They can be thought of similarly to a floating-rate yield. Duration risk will be a key consideration once interest rates start to rise, and merger arbitrage is one of the few fixed income-like strategies that will do well in a rising rate environment. This is important for fixed income investors to consider given interest rates are at all-time record lows and bond portfolios will be punished when rates rise. Merger Arbitrage Sub-Strategies and Deals Everything above describes funds that bet on announced deals in which the acquirer has made a specific offer for the target.

But there are two broad categories within merger arbitrage: funds that bet on announced deals and those that bet on pre-announced deals i. In addition to these categories, some investments involve active arbitrage i. Merger Arbitrage Deal Analysis Investment analysis here is based on the spread that will be closed if the deal closes, which depends on the value of the target and acquirer, the certainty of close, the estimated time to close, and special deal terms e.

Besides valuing the target, acquirer, and combined entity, you could also look at the merger yield, which equals the estimated annualized return divided by the merger spread. This merger yield might also include other adjustments, such as deductions for the short borrow cost and trading commissions, for more accuracy. The merger yield tells you how lucrative a deal is based on other deals in the market with similar success probabilities.

So, valuation is important for setting a floor on your potential losses. The Top Merger Arbitrage Hedge Funds Almost all the large, multi-manager hedge funds use event-driven strategies, and merger arbitrage is one of the best-known within this category. Other well-known names that offer merger arb mutual funds include SilverPepper and Kellner Capital. If you want to read about one of the top portfolio managers in the field, check out this article about Drew Figdor at Tiedemann.

Some lawyers also end up at these funds, especially if they understand anti-trust law and the regulatory approval process. This strategy is part art and part science, and you can find funds everywhere on the spectrum. As with hedge fund recruiting everywhere: Expect mostly off-cycle processes based on referrals, networking, and headhunters at the larger firms.

Interviews tend to involve discussions of your past investments and current investment ideas, which should be tailored to this strategy. The single-manager vs.

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