A look at the Merger Arbitrage strategy

Between 1998 and 2022, Merger Arbitrage strategies delivered a 4.4% annualised return, or about 200bp above the risk-free rate over the same period.¹ Capturing the spread from officially announced global Merger & Acquisition deals, Merger Arbitrage strategies provide an alternative approach thanks to its strong decorrelation from traditional asset classes.

Merger Arbitrage strategy is especially suited for current market conditions, as it presents an effective hedge in rising rate or inflationary environment. The strategy often displays a lower volatility compared to stocks with low correlation with traditional asset classes such as equities and bonds.

Merger Arbitrage is an alternative strategy whose objective is to take advantage of price discrepancies, observed after the announcement of an M&A (Merger & Acquisition) transaction on a listed company.

After an M&A deal is announced, the stock price of the target company generally sits below the acquirer’s bid price for a period of time. This price discrepancy – called the Merger Arbitrage spread (or discount) – is what Merger Arbitrage investors aim to generate a return from if the deal goes through.

The reason for the spread is simple. A deal that’s just been announced still has a while to go before it’s finalised, because there are a number of hurdles yet to overcome: putting the deal to a shareholder vote, getting approval from antitrust regulators, making sure all agreement terms are met, obtaining financing, and so on.

The Merger Arbitrage spread – or the return an investor can expect to receive – is the sum of two factors:

• A risk-free rate, which corresponds to the time value of money between when a deal is announced and when it’s finalised.
• A risk premium associated with the probability of deal failure.

The advantage of a Merger Arbitrage strategy lies in the risk premium. First of all, because the risk is idiosyncratic – the success or failure of an M&A deal depends very little on market conditions and is instead dictated by the fundamentals of the deal in question. And second, because the probability of the risk materialising is very low: over 90% of deals that are officially announced end up being finalised under the initial terms.²

Investors have two ways of capturing a Merger Arbitrage spread. If the deal will be paid for in cash, investors can simply buy stock in the target company. If the deal will be paid for with stock in the acquiring company, investors can buy stock in the target company and at the same time sell stock in the acquiring company under the terms of the offer.

At Carmignac, we’ve been expanding our alternative-investment capabilities for years and currently manage nearly €2 billion in this asset class. We formed a Merger Arbitrage team and appointed Fabienne Cretin-Fumeron and Stéphane Dieudonné as Fund managers. This move came in response to growing demand from investors seeking to diversify away from conventional asset classes and into those with reduced volatility and uncorrelated returns.

We launched two Merger Arbitrage Funds: Carmignac Portfolio Merger Arbitrage, which has a defensive profile and 2%–4% expected volatility; and Carmignac Portfolio Merger Arbitrage Plus, which is more dynamic and has 5%–7% expected volatility. These funds aim to seize M&A opportunities in the main developed countries. They’re both classified as Article 8 under the SFDR and are open to professional and retail investors in several European countries.