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A Low-Expense Alternative to Bonds

Tue, 3 Jun 2014

This merger-arbitrage fund has little correlation to the broader equity and fixed-income markets and has a very low expense ratio.


Video Transcript

A.J. D'Asaro: The Morningstar Fund Medalist of the Week is the Merger Fund advised by Westchester Capital Management. Westchester was the first firm to offer merger-arbitrage in mutual fund format when this fund debuted in 1989.

Merger Arbitrage is a market-neutral strategy, which involves going long a target company in a publicly announced merger agreement and short in the acquisitor, and capturing that spread in between.

Merger-arbitrage returns have come down substantially in the past five years, but given the low-bond-yield environment we feel that this strategy still offers a compelling return prospect.

While this fund sailed through 2008 with ease, losing only 5% as the market cratered more than 50%, there are some risks to investing in merger-arbitrage. Namely, any kind of idiosyncratic event that would cause a lot of merger deals to fail would negatively affect this fund. 

For example, in 2002 in the wake of the Enron crisis, many utility mergers collapsed, and this fund lost 14% from January to November 2002, though some of those deals did close and it finished the year down 5.7%. That was the worst loss that this fund experienced in its 25-year history. So that can be a worst-case scenario for investors to expect.

In addition to this fund's low correlation to the stock and bond markets, this fund is offered at a very low expense ratio. 

Bottom line, the Merger Fund represents an attractive risk/reward profile without interest-rate risk, which makes it a decent alternative to bonds in the current interest-rate environment.

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