Patricia Oey: Merger-arbitrage funds seek to capture the spread between the discount at which an acquisition target trades at prior to the completion of a merger relative to its acquisition price. These types of strategies can offer diversification benefits as they usually have a low beta to stocks and bonds, and thus can help stabilize a portfolio when equity markets become more volatile and/or in a rising rate environment. Currently, merger and acquisition activity may benefit from last year's corporate tax cuts, which is putting more cash on company balance sheets. The recent court approval of AT&T's acquisition of Time Warner is also likely to buoy sentiment for deals in the near term. Rising M&A deal volume is a positive for merger arbitrage funds, as it broadens their investment opportunity set.
There are two merger-arbitrage mutual funds with relatively long track records and experienced managers. One is called Merger, and the other is called Arbitrage, and each carry a Morningstar Analyst Rating of Bronze. Each, on average, invest in about 40 to 80 deals, but their portfolios tend to not have much overlap, and this can result in some performance differences. Merger usually tilts more toward larger cap and has a small allocation in event-driven ideas. Arbitrage focuses more on mid-caps, where spreads might be slightly wider, and they do not have an event-driven sleeve. Merger and Arbitrage carry fees of 1.22% and 1.26%, respectively, which is reasonable relative to equity alternative peers but a bit pricey on an absolute basis.
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Patricia Oey does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.