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Global Deal Is a Play on M&A

Christopher Sahl

The closed-end (GDL)Gabelli Global Deal Fund (GDL), which raised $370 million in an initial public offering last week, offers small investors another way to capitalize on the boom in corporate merger activity.

But don't expect to reap hedge-fund-like performance.

Although the strategy employed by merger funds is more commonly associated with private investment pools that cater to the wealthy, their returns are generally unexciting. The $207 million (GABCX)Gabelli ABC Fund (GABCX), an open-end fund with a similar strategy that is run by the same manager, Mario Gabelli, is up 1.6% for the year through Wednesday and has returned an annualized 6.7% over the past three years, according to Morningstar.

In fact, most merger funds are marketed on their "absolute returns," or their ability to make money in any market environment.

Merger funds generally profit by purchasing shares of companies involved in mergers, takeovers, spinoffs and other kinds of deals. The shares of companies being acquired typically don't realize their full purchase price until the deal is completed, because investors recognize that there is some risk the deal won't go through. When a deal is completed, fund managers pocket the difference between the price they paid and the acquisition price.

The strategy involves some risk, however. If a deal does fall through, a company's share price can fall back to its preacquisition level.

Returns also can suffer if a number of arbitragers pile into the same deals, narrowing the spreads between the share prices of companies involved in mergers and their acquisition prices.

That could happen if the volume of corporate-takeover activity backs off its recent highs, leaving more money chasing after fewer transactions. Global M&A rose 37.9% in 2006 to $3.8 trillion, shattering the previous record of $3.4 trillion during the peak of the freewheeling dot-com boom in 2000, according to Thomson Financial.

Kerry O'Boyle, a fund analyst at Morningstar, says that Gabelli doesn't follow conventional merger arbitrage strategy, because "he tends to buy one side of the deal" and doesn't hedge his risk by shorting stock of the acquiring company.

With the launch of Global Deal, Gabelli's Gamco Investors(GBL) appears to be banking on the growing impact of private equity to sustain corporate takeover activity.

Private-equity firms participated in 19.9% of global M&A activity, pouring in $757.6 billion in 2006. In addition, activity continued to increase in developing countries, with booming industrial and commercial growth in nations such as India, China, Brazil and Russia, according to the Thomson survey.

Like the ABC fund, Global Deal will invest primarily in domestic and foreign securities involved in publicly announced takeovers, mergers, leveraged buyouts and tender offers. To a lesser extent, it will invest in companies undergoing corporate reorganization strategies such as liquidations, spinoffs and "stubs," or subsidiary target companies that are not included in the deal.

O'Boyle says that while he expects Gabelli to generally stick close to his management style with Global Deal, the new fund has a few distinctions. "While Gabelli ABC is not necessarily limited to the U.S. market, this will have more of a global flavor to it," he says.

Global Deal plans to invest at least 40% of its assets in mergers, takeovers, leveraged buyouts and tender offers that occur outside the U.S.

O'Boyle adds that Global Deal "goes further out than ABC" by targeting corporate reorganization events in addition to M&A.

(Gabelli also runs the $662 million (EMAAX)AXA Enterprise Mergers and Acquisitions (EMAAX), which O'Boyle calls "kind of a clone" of the ABC fund.)

There may be some benefit to betting on the outcome of announced deals through a closed-end fund. Unlike open-end funds, which continuously issue and redeem shares, closed-end funds issue a fixed number of shares that trade throughout the day, like stocks. That means managers don't have to keep extra cash on hand to meet redemptions, so they can remain fully invested, maximizing their funds' returns.

But the share prices of closed-end funds can move independently of the net asset value of their holdings. So investors who buy the fund are taking on the additional risk that they won't be able to realize the full value of their investment when they want to sell. That's particularly true when you buy pay a premium for shares, as investors did in Global Deal's IPO.