Private Equity for the Little(r) Guy

Getting your clients a piece of global M&A action—2006 has seen a near-record $3.6 trillion in deal activity—doesn’t have to involve ponying up massive minimums (and fees) for shares of a private equity fund or fund of funds. There are a handful of merger-arbitrage mutual funds out there that may fit the bill.

Getting your clients a piece of global M&A action—2006 has seen a near-record $3.6 trillion in deal activity—doesn’t have to involve ponying up massive minimums (and fees) for shares of a private equity fund or fund of funds. There are a handful of merger-arbitrage mutual funds out there that may fit the bill.

“There are a couple of ways for retail investors to get in on the M&A activity,” says Rick Lake, a co-chairman with Lake Partners, a money-management firm in Greenwich, Conn. “You can buy stocks that are perceived as M&A targets or you can seek out mutual funds with merger-arbitrage strategies,” he says.

These merger funds, as they’re known, are low risk and have low correlation to core portfolio allocations. After a merger deal is announced, merger funds buy the companies targeted for acquisition hoping to make money on the “spread”—the difference between the market price of the target company and the offering price of the acquirer. “Basically, the attraction of an M&A-strategy fund is diversity from other asset classes and low risk,” says Todd Trubey, a Morningstar analyst who covers arbitrage funds. “They’re low risk, but not always low return, and in good years they can do very well—it’s an absolute return style strategy,” he says. Trubey says a 6 percent to 10 percent return over long periods of time is generally what’s expected of these funds, with low volatility. “And they’ve pretty much done what’s expected of them,” he says.

Some merger arbitrage funds to consider are:

Merger Fund (MERFX):
Morningstar category: Long-short
Risk: Below average
Load: no load
Expense ratio: 1.36 percent
Minimum investment: $2,000
Assets: $1.5 billion
Total return since inception in 1988: 8.3 percent*

Arbitrage Fund (ARBFX):
Morningstar category: Long-short
Risk: Below average
Load: no load
Expense ratio: 1.95 percent
Minimum investment: $2,000
Assets: $174 million
Total return since inception in 2000: 6.5 percent*

AXA Enterprise M&A Fund (EMAAX):
Morningstar category: Mid-cap blend
Risk: Low
Load: 4.75% front-end
Expense ratio: 1.71 percent
Minimum investment: $2,000
Assets: $594 million
Five-year annualized return: 7.45 percent (through 11/30/06)

Gabelli ABC (GABCX):
Morningstar category: Mid-cap blend
Risk: Low
Load: no load
Expense ratio: 0.64 percent
Minimum investment: $10,000
Assets: $193 million
Ten-year annualized return: 7.18 percent (through 11/30/06)

Source: fund Web sites
*According to Morningstar data

Rob Isbitts, president and chief investment officer of Emerald Asset Advisors, says he particularly likes the AXA Enterprise M&A Fund because it goes a step further than these other funds: Manager Gabelli and his team buy stocks they think will be party to a merger deal. “I typically use this one in a more aggressive allocation model,” says Isbitts. His firm uses mutual funds like these merger-arbitrage funds and other long-short funds and ETFs to replicate the strategies of hedge funds.

The Gabelli ABC fund is a different animal from the other three funds—it is not a true arbitrage fund. It only buys the stock of the company targeted for acquisition, whereas the others typically short the acquiring company’s stock also.

Morningstar’s Trubey says there are only a handful of merger-arbitrage funds out there because the strategy is complicated and specialized and difficult to do well. “It’s very hands-on. The key thing is to be able to assess whether a deal will close, and there’s no way to simply screen for that,” says Trubey. And, says Isbitts, “That’s one reason we like them.”

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