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Arbitrage With John Orrico

Unless stocks take off in the fourth quarter, 2005 is shaping up to be snoozer for investors. When it comes to deals, though, it's already going down as a sizzler.

Low interest rates, clean corporate balance sheets and the urge to merge have turned 2005 into a banner year for mergers and acquisitions. According to John Orrico, portfolio manager for the $123 million (ARBFX) fund, an open-end mutual fund that invests in both stock and cash deals, global M&A volume through September was $1.75 trillion, up from $1.25 trillion last year. Europe alone is on target to crack the $1 trillion mark for the first time since 2000, says Orrico.

As for his own fund, the Arbitrage Fund is flat this year, compared with a 1.5 percentage-point loss for the S&P 500. But don't judge its performance too harshly; the fund isn't designed to correlate with the greater market, an element that makes it a welcome addition to a diversified portfolio. checked in with the arbitrager Orrico to get the down-and-dirty on investing in deals.

How would you describe your fund's strategy?

We run a mergers-and-acquisition based risk arbitrage fund, which means we invest in things like announced deals, spinoffs and corporate reorganizations. While that may sound overly complicated, our goals are fairly simple: capital preservation and consistent positive returns which are noncorrelated to equity or fixed income markets. Over the past five years we are up about 7% annualized, vs. negative 2% for the S&P 500.

Could you give a recent example of a deal you invested in?

Federated's (FD) purchase of May is a good example. That was a stock and cash deal where the time line was dependent on an antitrust review. The deal, which closed in about six months, was $17.75 cash plus 0.3115 share of FD for each share of MAY.

For every share we bought of May, we shorted 0.3115 shares of FD in order to lock in a spread of about 6% gross. So on an annualized basis, we earned about 12%. This was a $12 billion deal and faced some intense scrutiny from antitrust regulators concerned about concentration in the retail market.
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