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Contrarian Picks: Don’t Dismiss These Liquid Alternative Funds

These arbitrage strategies can offer consistent income with little market sensitivity.

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Securities In This Article
The Merger Fund A
Calamos Market Neutral Income A
Vanguard Total Bond Market Index Adm
Vanguard Total Stock Mkt Idx Adm

Funds in the relative value arbitrage and event-driven Morningstar Categories faced outflows totaling $2.4 billion and $6.3 billion, respectively, in 2023. This wasn’t surprising since 2022′s tough economic landscape challenged funds from both categories, which rely on corporate activity such as refinancing by growth companies with convertible bonds or in mergers and restructurings to make money. And 2023 wasn’t so easy, either—convertible-bond issuance recovered but not nearly to 2021 levels, and merger activity was suppressed. Still, we know of offerings from both categories designed to deliver consistent income with little market sensitivity. And with fixed income offering more variable diversification benefits, don’t dismiss these alternatives.

Calamos Market Neutral Income CVSIX carries a Morningstar Medalist Rating of Bronze. The fund combines two primary complementary strategies—a convertible-arbitrage sleeve with a hedged equity component—in pursuit of steady returns while mitigating drawdowns and interest-rate sensitivity. Convertible-bond arbitragers generate returns by trading the relative valuations between a convertible bond, the underlying stock, and its related options.

Eli Pars leads the five-person portfolio management team. With over 35 years of investment experience and more than two decades specific to convertible arbitrage, his experience stands out. Pars’ comanagers also bring convertible-arbitrage and options-trading expertise and average nearly 20 years of industry experience. The team collaborates on asset allocation and security selection, tapping a pool of sector specialists to support its research efforts.

Deep fundamental research underlies the established process behind The Merger Fund MERFX. The Bronze-rated offering avoids more speculative, soft-catalyst events. Rather, it generates profits by investing in announced mergers, acquisitions, and other corporate reorganizations, aiming to capture the spread between a target company’s stock price at the announcement and the acquisition price.

Comanagers Roy Behren and Michael Shannon each have more than three decades in the investment industry, more than 25 years at the firm, and over 15 years on this fund. The duo’s deep fundamental research and expertise in corporate actions have enabled them to invest successfully in droves of deals that closed. The supporting investment team helps identify opportunities with strong fundamental characteristics and monitor the deals in the portfolio.

In the 10 years ended May 2024, Calamos Market Neutral Income and The Merger Fund’s respective standard deviations (a measure of volatility) were 3.4% and 3.0% annualized, respectively, well below the Bloomberg U.S. Aggregate Bond Index’s 4.9%. And in the past 10 calendar years, both funds delivered positive returns in as many or more instances than the index. The Calamos fund’s one losing year in that period was 2022 when it leaked 4.5% while the index hemorrhaged 13%; and Merger’s losses in 2015 and 2021 were less than 1%, while the index returned less than 1% in 2015 and lost more in 2021.

With the potential to provide steady returns without upending a portfolio’s risk profile, both options can be additive in place of some bond exposure. Take a portfolio with 60% invested in Gold-rated Vanguard Total Stock Market Index VTSAX and 40% in Silver-rated Vanguard Total Bond Market Index VBTLX as a proxy for the typical US-only balanced fund. A more diversified option with a 15% stake in The Merger Fund—taken from the bond helping—outpaced the 60/40 in the 10 years ended May 2024 in total and risk-adjusted returns (measured by Sharpe ratio) annualized. The swap also resulted in a shallower maximum drawdown, less market sensitivity (measured by beta relative to the S&P 500), and lower volatility. Allocating instead to Calamos Market Neutral Income marginally increased volatility and beta but more substantially boosted returns, still resulting in a better risk-adjusted outcome.

This article first appeared in the May 2024 issue of Morningstar FundInvestor. Download a complimentary copy of FundInvestor by visiting this website.

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

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About the Author

Karen Zaya, Ph.D.

Senior Analyst
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Karen Zaya, Ph.D., is a senior manager research analyst for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. She covers multi-asset and alternatives strategies.

Before joining Morningstar in 2021, Zaya taught at Hunter College, and before that she was a postdoctoral assistant professor at the University of Michigan, where she conducted research in mathematical fluid dynamics and taught undergraduate courses.

Zaya holds a doctorate degree in mathematics from the University of Illinois at Chicago.

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