A Measured Approach to Merger-Arbitrage

Josh Charlson: Bronze-rated Arbitrage Fund is in Morningstar's market neutral category, and it pursues a merger-arbitrage strategy. Merger-arb funds take advantage of what's known as the spread, where the difference in an announced merger deal between the price announced at acquisition and the price at the close. And usually, merger-arb managers will invest long in the acquiree and at times short the acquirer to hedge the risk.

One of the things we really like about Arbitrage Fund is the expertise and tenure of the management team. Manager John Orrico founded Water Island Capital in 2000 and his two co-portfolio managers joined the firm in 2003, so they have a lot of experience.

Another thing we like about this fund is their attention to risk management. One of the big risks with merger-arb is that the deal will fall apart, and they pay a lot of attention to the regulatory risks around a potential merger deal and they have done a very good job of avoiding potential deal breaks even with a very concentrated portfolio.

The merger-arb space has been a really interesting area lately because of the number of deals going on. Returns have been somewhat compressed because of low interest rates as well as relatively narrow spreads in the area. However, we really like the diversification potential that merger-arb provides. This fund has low correlation to equities and bonds and we like the well-managed strategy here, the low volatility, and competitive fees relative to other merger-arb funds in the space.