This Day On The Street
Continue to site
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

Why Rising Interest Rates Could Help Merger Funds

Wealthy investors have long prized merger arbitrage hedge funds because they are seen as safe. Most deals do close and generate small profits for arbitrage investors. More importantly, the merger funds offer diversification since the returns are not necessarily dependent on the direction of the overall stock or bond markets

The returns of merger funds tend to track interest rates. As rates climb, so do returns. This occurs because merger investors shy away from deals unless they promise to deliver returns in excess of the risk-free rates of Treasury bills. Under normal circumstances, promising deals tend to produce annualized returns that are about 4 percentage points above yields on Treasury bills.

If Treasury bills yield 2%, then investors will not buy a deal stock until they can get annualized returns of about 6%. When Treasury rates rise to 3%, investors will seek to obtain returns of 7%. If the spread between the current share level and the final deal price is too narrow, merger investors will sit on the sidelines until the price sinks.

At the moment, three-month Treasury bills yield almost nothing, so safe deals promise to generate annualized returns of about 4%. In a pending deal, Hanesbrands (HBI) announced it would pay $23.50 a share for Maidenform (MFB). The shares currently trade for $23.38, and the deal is expected to close in the fourth quarter. If things run smoothly, investors could obtain annualized returns of about 4%.

To spread its bets, Arbitrage Fund typically invests in 40 to 60 transactions. While some deals close in 30 days, others take several months. The aim is to book quick gains, and then reinvest the proceeds in other deals. If a deal turns sour, the managers cut their losses and move on to more promising opportunities. Portfolio manager John Orrico holds a mix of different kinds of deals, including safe choices and riskier opportunities that can deliver higher returns.

Among his riskier positions currently is Dell ( DELL). The shares trade for $13.73, and a group led by Michael Dell has promised to pay shareholders a package worth $13.95. Orrico figures that the deal will close in October, producing an annualized return of around 9%. Carl Icahn and some other big shareholders oppose the deal. But Orrico thinks that the acquisition will close because many shares are now in the hands of arbitrage funds that would profit from the sale.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.
Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.
2 of 2

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Only $9.95
14-Days Free
Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Real Money

More than 30 investing pros with skin in the game give you actionable insight and investment ideas.

Product Features:
  • Access to Jim Cramer's daily blog
  • Intraday commentary and news
  • Real-time trading forums
Only $49.95
14-Days Free
14-Days Free
MNA $28.51 0.00%
AAPL $93.74 0.00%
FB $117.58 0.00%
GOOG $693.01 0.00%
TSLA $240.76 0.00%


Chart of I:DJI
DOW 17,773.64 -57.12 -0.32%
S&P 500 2,065.30 -10.51 -0.51%
NASDAQ 4,775.3580 -29.9330 -0.62%

Free Reports

Top Rated Stocks Top Rated Funds Top Rated ETFs