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Merger arb funds step up to the plate

return to M&A's new dealmakers set to take the stand

A massive allocation shift out of long-only public market investment vehicles and into alternative investments means that hedge funds are playing an increasingly dominant role on the buy side – particularly in determining the outcomes of M&A transactions. 

Although merger arbitrage funds, a type of special opportunity vehicle, represent perhaps less than 10% of the total alternative investment universe, they take a big share of high-profile M&A deals, routinely snapping up more than half the free-floating equity. Some analysts estimate that there is now roughly $1 trillion in a huge assortment of funds targeted at financing and betting on buyouts – whether MBOs, LBOs, M&As, or private-equity infusions.

Merger arb plays

Typically, a merger arb fund buys the stock of the company about to be taken over, such as MCI, and shorts the acquiring company, such as Verizon, betting that the resulting share price movements will work to their advantage. Historical data strongly support the validity of this strategy as the acquirer's shares usually underperform the market from the point of deal announcement to around the time of its closing.