Investing in merger arbitrage has many potential advantages, including low correlation and low beta to those of the stock or bond markets, as well as considerably less volatility than equity markets, as reflected by standard deviation.
Especially relative to the current environment, merger arbitrage has tended to be positively correlated with interest rates, or the cost of capital; if interest rates rise, the strategy’s performance may provide a hedge against the decreased value of bonds, according to Virtus.
Merger arbitrage index returns historically have been better during periods of inflation. One reason is that higher inflation tends to lead to higher rates, and higher rates tend to increase the merger arbitrage spread.
Amid the challenging economic climate in 2022, bogged down by geopolitical tensions, inflation, and rising interest rates, the portfolio management team for the Merger Fund (MERFX) is determined to maintain the fund’s unique risk profile — positive performance in 29 out of 33 years — while attempting to return the fund’s performance to its historical trend line, according to the firm.
“We anticipate a continued trend of robust activity across a wide range of industry groups for 2022,” the firm writes. “Against the background of insipid top-line growth, consolidation offers one of the few ways to improve profitability in such a zero-sum environment. With so many companies under pressure to consider strategic business combinations, we believe transformational corporate transaction activity will likely remain strong for the foreseeable future.”
Merger arbitrage is an “absolute return” strategy characterized by investments in companies involved in pending mergers, takeovers, and other corporate reorganizations, with the goal of profiting from the timely completion of these transactions.
Investments trade on idiosyncratic deal dynamics and tend to have low correlation with other situations within a portfolio; the outcome of a single transaction will likely not impact the outcome of other portfolio investments. Investment returns are driven primarily by the outcome of the specific transactions rather than the direction of equity or bond markets.
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