Merger Arbitrage in a Rising Rate Environment

Investors looking for investments that are well-positioned for inflationary and higher interest rate environments should consider adding a merger arbitrage strategy to their portfolios. 

The Federal Reserve issued a statement on Wednesday, holding short-term interest rates steady but signaling intentions to raise them in mid-March, the latest update on plans to remove stimulus to temper high levels of inflation.

Inflation has been top of mind for investors for months. The Consumer Price Index reading for December showed a 7% year-over-year increase and marked the largest jump since the early 1980s.

Merger arbitrage index returns have historically fared better during periods of inflation due to the fact that higher inflation tends to lead to higher rates, and higher rates tend to increase the merger arbitrage spread.

The Merger Fund (MERFX), managed by Virtus affiliate Westchester Capital Management, the first mutual fund devoted exclusively to merger arbitrage, has historically outperformed bonds in rising rate environments.

The Bloomberg U.S. Aggregate Bond Index has had 28 negative quarters since the inception of MERFX in 1989. 96% of the time, the fund (at NAV) outperformed the Bloomberg U.S. Aggregate Bond Index, according to data from Morningstar and Westchester.

In the last decade, there have been three periods where this trend can be observed.

During the segment between August 2020 and September 2021, MERFX’s annualized returns were 2.82%, compared to taxable and tax-exempt bonds, which saw annualized returns of -0.66% and 1.57%, respectively, according to Morningstar and Westchester.

From June 2016 through the end of 2018, MERFX saw 4.75% in annualized returns, compared to taxable and tax-exempt bonds, which saw annualized returns of 0.37% and 0.92%, respectively, according to Morningstar and Westchester.

During the period of July 2012 through the end of 2013, MERFX saw annualized returns of 4.04%, compared to taxable and tax-exempt bonds' annualized returns of -0.17% and 0.81%, respectively, according to Morningstar and Westchester.

The same trend is observed in previous periods of rising rates, including August 2010 through March 2011, December 2008 through March 2010, and many others in earlier decades.

MERFX also offers the benefit of diversification. Deal risk is modestly to negatively correlated to conventional asset classes, so adding a merger arbitrage strategy to a portfolio may provide added diversification of risk.

For more information, visit Virtus.

For more news, information, and strategy, visit the Alternatives Channel.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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