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Upsets Hit Merger Arbitrage Investors

Helen Thomas, Dan McCrum and Neil Hume Financial Times

Merger arbitrage investors are braced for a second consecutive month of losses with a string of unexpected upsets leading to a difficult period for the hedge fund strategy.

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Arbitrageurs – who invest during takeovers in the hope of capturing the difference between the target’s stock price and the eventual value of a deal – finished down slightly in May, according to Hedge Fund Research’s global data.

With a week left to run in June, the strategy is down a further 1.38 per cent, leaving it scarcely in the black for the year.

That leaves deal investors facing back-to-back months of negative performance for the first time since late 2008, when the financial crisis hit markets.

Merger arbitrage funds have enjoyed successive quarters of inflows as investors eye a pick-up in deals as the global economy recovers. The sector has more than $18bn under management globally.

However, in recent weeks several transactions have faltered, dealing a blow to those betting on speedy returns. Heightened equity market volatility has also increased fears that discussions will be shelved and parties will find it harder to agree deals.

Last week, Avis Budget’s $1bn agreement to buy Avis Europe sent shares in US rival DollarThrifty tumbling almost 10 per cent as hopes of a bidding war between the car hire operator and Hertzevaporated.

Nasdaq last month halted its pursuit of NYSE Euronext, after US regulators threatened to block a deal. Canadian miner Lundin abandoned plans to sell itself after bids failed to impress the board.

“The last six weeks have been very difficult,” said one merger arbitrage investor. “There is definitely a de-risking going on ... People get gun-shy.”

In Europe, the UK Takeover Panel last month denied an appeal from Kalahari Minerals to let China Guangdong Nuclear Power lower its indicative price in talks with the Aim-listed group. Other deals, including News Corp’s bid for BSkyB, are tied up awaiting government approvals.

“If deals break when interest rates and spreads are so low, it really begs the question: is it worth the risk?” said one fund of fund manager.

With inflows of $706m in the first quarter, the strategy has so far remained in favour.

Ric Thomas, head of alternative investments at State Street, has raised his allocation to merger arbitrage in the past couple of years.

“[However,] across the board – not just in hedge funds but the whole world of investing – there are not a lot of cheap, screamingly obvious strategies right now,” he said.

Those investing in so-called special situations – usually more speculative transactions – have also had a tough time.

Auctions, including that of US retailer Big Lots , have failed to result in a sale, while other processes have moved more slowly than expected.