A hedge fund strategy without the high fees


Merger arbitrage strategies are used by some investors to get alternative exposure to the stock market with diversification benefits and potentially less volatility.

Atlas Capital manages a merger arbitrage portfolio on Covestor with a twist.

MergerArb portfolio is designed to identify companies that could be acquired, and profit from the deal premium.

“We think of this portfolio as ‘alternative beta’ at a lower cost than what hedge funds are typically charging,” said Jonathan Tunney, founder and chief investment officer of Atlas Capital. In financial jargon, beta is typically referred to as index-based, passive exposure to the market.

Scott Bilter, who runs MergerArb on the Covestor platform, said the portfolio differs somewhat from traditional merger arbitrage strategies. For example, merger arbitrage funds typically buy the company being acquired and short the acquirer.

However, Bilter does not short stocks because Atlas Capital wants to make the strategy available in tax-deferred accounts such as IRAs, which typically don’t allow short-selling. Merger-arbitrage strategies can have high turnover and generate short-term capital gains, so it may make sense to hold them in an IRA. Because of the limitation on shorting, Atlas only invests in “cash only” or “cash and stock” deals, and avoids “stock only” deals.

MergerArb usually holds five stocks that are equally weighted, although it can hold more when M&A activity picks up.

“The deal market has been fairly quiet lately,” Bilter said.

He noted there has been a trend of regional banks buying each other lately, although “spreads” or premiums have also been somewhat narrow in recent deals, which reduces the potential for profits.

When considering stocks to buy, Atlas Capital looks for deals that could result in at least 10% annualized gains for the shares of the company potentially being acquired. It also employs liquidity screens in MergerArb portfolio. For example, it typically looks for stocks with at least 100,000 shares of daily trading volume (prior to any merger announcement) and a stock price of at least $5.

“Overall, there aren’t many deals now with acceptable risk,” Bilter said.

In general, he tends to shy away from high-volatility names. One of the strategy’s main risks is that an announced deal sours. Although it may not continue in the future, the portfolio so far has had lower volatility than the S&P 500.

Photo Credit: Ybot84

DISCLAIMER:  The investments discussed are held in client accounts as of November 30, 2013.  These investments may or may not be currently held in client accounts.  The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable.  Past performance is no guarantee of future results.