Simultaneous erosion in both bonds and equities this year is prompting some investors to evaluate alternative strategies. However, market participants that are new to the world of alternatives may think this segment complex and confusing. Fortunately, some funds make what appear to be complex concepts approachable for a broad swath of investors. That group includes the Merger Fund (MERFX).
As its name implies, MERFX is a merger arbitrage fund — a strategy that certainly fits the bill as “alternative.” Potentially boosting the allure of MERFX is that merger arbitrage has a documented history of doing what alternative strategies are supposed to do, but not all accomplish: enhance diversification while reducing correlations to traditional asset classes. That’s something to consider at a time when 60/40 portfolios are under duress.
“Providing true portfolio diversification requires a durable return stream that’s disconnected from the ups and downs of the overall market. Alternative strategies with a low correlation to broad asset classes can act as a buffer when other assets in the portfolio are under pressure—the missing component in 60/40 portfolios today,” according to BlackRock.
More so than some traditional alternative strategies, MERFX could be a credible consideration for investors looking for protection in what could be a lengthy run of macroeconomic uncertainty.
“The substantial increase in inflation and the potential for a more persistent contribution to macro uncertainty from inflation in a post-COVID world of structural change suggests we are entering a new regime of greater volatility. Inflation and policy dynamics are putting pressure on stocks and bonds—undermining the diversifying nature of the traditional ‘balanced’ portfolio that investors have relied on for decades,” added BlackRock.
Another benefit of MERFX is that although it holds stocks — obviously essential to a merger arbitrage strategy — the arbitrage mechanism can add an element of market neutrality. Market neutrality could be a coveted trait at a time when inflation is high throughout much of the developed world and economic growth is stagnating.
“Looking ahead, with greater uncertainty in the directionality of beta exposures in an environment of rising recession risk, as well as heightened inflation uncertainty undermining negative stock-bond correlations, investors may consider diversifying portfolio exposures to include alternative strategies that can implement long AND short exposures,” concluded BlackRock.
MERFX currently holds 79 long positions and seven short positions, with the latter representing 3.58% of the fund’s assets, according to issuer data.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.