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As Mergers Revive, Risk Arbs Make a Comeback

The business of betting on mergers and acquisitions is coming back from the dead.

As Wall Street insists that the merger business will rise again, hedge funds are pouring money into betting on the outcomes of those mergers in a strategy known as merger, or risk, arbitrage.

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“We’re seeing people dip their toe back in the water and participate,” said Keith M. Moore, a managing director at MKM Partners in Stamford, Conn., who wrote the book on the subject (“Risk Arbitrage: An Investor’s Guide.” He is working on a second edition). “The shops that did exit the business are re-entering or considering re-entering.”

Being an arbitrageur sounds simple: Buy the securities of companies that are the target of a merger or a spinoff. Arbitrageurs then make their money on the “spread” — the difference between the announced price of the deal and the amount the stock gains until the deal actually closes.

One reason for this resurgence is there is more to bet on this year. The volume of announced global mergers and acquisitions through the third quarter was up 21 percent from the year-earlier period.

The strategy can be immensely profitable. A bidding warbetween Hewlett-Packard and Dell for 3Par sent 3Par’s stock up from $9.65 before the bids to a final $33 a share, or $2.35 billion, that HP agreed to pay. Arbitrageurs who bet on the deal profited richly.

In most cases, however, the returns on risk arbitrage are modest and steady unless a deal falls apart. A Credit Suisse index puts the year-to-date return at around 4 percent, and an industry analyst estimates that it will end the year at as much as 7 percent — a decent return for an investment that usually takes less than a year to come to fruition.

“Arbitrage is the business of picking up pennies in front of steamrollers,” said Laurie Pinto, chief executive of North Square Blue Oak Capital in London, which works with hedge funds on arbitrage bets. Despite the word “risk” in the name, most arbitrageurs tend to be highly conservative.

Still, it is a risk that fewer Wall Street banks are taking with their own money. Many Wall Street banks stopped after deals were broken at a record pace in 2008 and 2009. The regulatory overhaul of the Dodd-Frank Actwill also make it harder for banks to put their own money on the line in risk investments.

As a result, there has been an arbitrageur diaspora. The teams from those banks, either laid off or fearing layoffs, dispersed to join hedge funds or dedicated arbitrage funds to keep directly investing in deals.

The banks have satisfied themselves with earning fees as middlemen. Market participants say Goldman Sachs, Morgan Stanley, JPMorgan Chase, Barclays, Credit Suisse, Bank of America-Merrill Lynch and Deutsche Bank have been increasing staff to help hedge funds buy and sell the merger stocks.


So far this year, there has been a noticeable boom: nearly 40 banks and financial companies have started or expanded teams to advise hedge funds, according to an analyst at a major firm who tracks the industry but would not be identified because of confidentiality agreements with clients.

Even so, hedge funds and arbitrage funds are cautious. “They’re picking and choosing the deals they’re in,” Mr. Moore of MKM Partners said.

It is easy to see why. Many arbitrageurs took a giant hit last week, betting incorrectly that BHP Billiton would succeed in its $39 billion bid for the Potash Corporation of Saskatchewan . Many arbitrageurs — and banks — are still shell-shocked from 2008 and 2009, when the financial crisis caused private equity firms to walk away from giant buyouts because of the difficulty of obtaining financing in closed credit markets.

As deals fell apart, arbitrageurs took large losses. Hedge funds like Citadel Investments, Perry Capital and Angelo, Gordon & Company got rid of nearly all their arbitrageurs.

It was a panicky time for a group of people already known for being high-strung. Arbitrageur is an odd profession that requires its practitioners to be part fortuneteller, part investor, part reporter and part gumshoe, gathering information from executives, board members, official filings, investment bankers, lawyers, regulators and news reports. They are the Hercule Poirots of the finance world, piecing together various and often conflicting stories to figure out who might murder a deal.

“It’s very hard to do it as an amateur, because you’re competing against people who have all these resources,” said Nancy Havens, a veteran arbitrageur and the founder of Havens Advisors. “You’ll probably buy at the wrong time and sell at the wrong time.”

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