“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.