As investors continue to flock toward commodities and other well-known inflation hedges, investors may be missing out on an especially well-positioned strategy: merger arbitrage.
Merger arbitrage is an alternative investment strategy offering investors the potential to create a more efficient and diversified portfolio, targeting both steady gains and minimization of drawdowns through up and down markets alike, according to Virtus
Unlike traditional investments, the performance of event-driven investments, such as the Merger Fund MERFX, is largely dependent on a number of identifiable variables, as opposed to market conditions.
The strategy invests in companies involved in pending mergers, takeovers, and other corporate reorganizations, with the goal of profiting from the timely completion of these transactions.
Each investment tends to trade on idiosyncratic deal dynamics and normally exhibits low correlation with other investments in a portfolio. In contrast to traditional long-only strategies, investment returns are driven primarily by the outcome of the specific transaction rather than the direction of equity or bond markets, according to Virtus.
Regardless of whether the market goes up or down during the pendency of the transaction, the value of the consideration to be received is a fixed dollar amount that the arbitrageur stands to make as a potential return, or spread, upon the successful closing of the deal, according to Virtus.
In general, merger arbitrage managers seek to make their investment strategies as market-neutral as possible, leaving the bulk of the portfolio’s exposure to whether specific corporate events occur. As a result, merger arbitrage strategies have been able to generate positive returns in most market environments, providing significantly less downside in bear markets, according to Virtus.
By including merger arbitrage in a diversified portfolio, investors have the potential to create a more efficient portfolio, targeting both steady gains and minimization of drawdowns through varying markets
MERFX’s returns historically have had low correlation with the stock market and near zero correlation with bond and commodities markets.
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