NEW YORK (TheStreet) -- An examination of the stocks that attracted the most hedge fund interest during the quarter showed managers had a taste for mergers and acquisitions.
TheStreet's look at hedge funds' top stock buys, ranked by market value of purchases, suggested that merger-arbitrage deals were the name of the game in the third quarter. A merger arbitrage deal typically involves buying the target's shares and shorting the stock of the acquirer, soon after a deal is announced, in order to take advantage of the premium between the offer price and the prevailing market price. However, in the case of all-cash deals, it could just mean taking a long position in the target, without a corresponding short position in the acquirer.
With deal activity seeing a significant revival in the third quarter, the strategy proved to be popular with hedge funds. Six out of the top ten stock buys during the period were targets of M&A activity.
The merger-arb strategy is not without risks in this bearish environment, where deals are taking longer to execute as acquirers and targets haggle over pricing terms. Last week, BHP Billiton (BHP) withdrew its nearly $40 billion hostile bid for Potash (POT) after it failed to win approval from the Canadian government, putting an end to a three-month long takeover battle.Stronger fundamentals may be helping to support the stock price of Potash, despite the failure of the deal. But in most cases, the shares of the target will retreat back to pre-offer levels if the deal fails, so the event risk is high. Investors may want to view the buildup of hedge fund interest in some of the stocks in the list below with caution, as it could represent a speculative bet on a deal taking place, rather than a directional view based on fundamentals.
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