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Making Sense of Merger-Arbitrage Funds

A primer on one of the oldest alternative strategies.

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Merger-arbitrage funds are navigating rough waters these days as M&A activity has slowed down and regulatory scrutiny has increased. These funds have shown some variation in their performance based on their level of diversification, concentration in specific deals, portfolio exposure to other event-driven opportunities, and cash holdings. Good funds stick with their core competency: Invest in the safer merger deals with reasonable return potential and low probability of a deal break. Investors who choose the more reliable funds may find that merger arbitrage still makes sense as a strategy to include in their portfolios.

Merger arbitrage is one of the oldest hedge fund strategies, often described as a subset of event-driven investing. The primary differentiator for event-driven strategies is the existence of a specific catalyst, an “event” to unlock value for the investor. This is distinctly different from investing on the basis of valuations, statistical relationships, and/or factor-based analysis. Merger arbitrage is also unique in that it has less reliance on an incremental investor to pay a higher price for a security because of favorable demand/supply characteristics.

Tayfun Icten does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.