One strategy that’s more insulated from economic uncertainty and the daily movements of the stock market is getting more love on Wall Street. Merger arbitrage trades aim to profit from the difference between a target company’s current stock price and the value of a takeover offer, so the strategy is typically unaffected by the macroeconomic worries at the top of investor’s minds, which today range from war in the Middle East, higher interest rates and a possible recession. Bill Gross, the former chief investment officer and co-founder of Pimco, touted such trades as his “best bets” lately after saying he’s negative on both bonds and stocks due to stubborn inflation. He said merger-arb plays can yield annualized returns up to 20%. Merger Arbitrage hedge funds gained 4.4% in the third quarter, standing out as the best-performing strategy for the period, beating every category in event-driven, equity, macro and value funds, according to Hedge Fund Research . “The merger arbitrage strategy has historically thrived in a rising interest rate environment when an investor’s fixed income portfolio may have suffered losses,” said Michael Peck, co-chief investment officer at First Trust. Sophisticated trading Merger arbitrage is a strategy that can involve buying shares of the target company that are trading at a discount to the offer price for any one or more of a host of reasons: regulatory or antitrust review, or the length of time before the deal is expected to close. Or, if the acquirer is public, mergers arbs might simultaneously short the stock of the acquiring company and go long the target. As the proposed deal nears completion, the target’s stock typically rises and the acquirer’s shares fall. So arb traders can make money on both sides of the bet. The 79-year-old Gross recently predicted the successful acquisition of Activision Blizzard by Microsoft after a lengthy regulatory review. He also highlighted an opportunity in Coach owner Tapestry’s $8.5 billion deal to acquire Michael Kors and Jimmy Choo parent Capri Holdings. Capri on Wednesday was selling for about $51 a share, or roughly 11% below Tapestry’s $57 cash offer. CPRI YTD mountain Capri Holdings Although merger arb plays are typically insulated from market volatility, there’s nonetheless great risk if acquisitions are blocked by regulators on antitrust grounds or fall apart for other reasons. For example, Gross said Broadcom’s $61 billion takeover of VMware is “a long shot.” Broadcom said Monday that it expects to close before the November 26 deadline amid concerns about winning China’s approval for the deal. Warren Buffett, a disciplined buy-and-hold value investor, has said that he has dabbled in merger arb throughout his career, including betting on the Activision-Microsoft deal. This short-term trading strategy often utilized by fast-money hedge funds typically involves multiple long and short positions, and might be too sophisticated for the average individual investor. However, there are a few exchange-traded funds utilizing the strategy that investors can readily access. The First Trust Merger Arbitrage ETF (MARB) and the IQ Merger Arbitrage ETF (MNA) are two popular ones that capitalize on the technique.
