Merger Fund lets small investors be part of billion-dollar acquisitions


September 18, 1994|By New York Times News Service

With merger activity on the rise, the Merger Fund is on a roll.

The fund allows small investors into the action for as little as $2,000, and they have pushed assets to more than $150 million as of last week, from $25.2 million in November, the end of the fund's fiscal year.

The attraction: a total return of 6.40 percent this year through Sept. 8, compared with a 1.17 percent return for the average equity fund, according to Lipper Analytical Services.

More than eight corporate takeovers of public companies have been announced each day this year on average, a record pace, according to the Securities Data Co. That offers big opportunities for "risk arbitrage," in which players like the Merger Fund pocket the difference between the market price of a target company's stock and the usually higher price the acquirer is offering.

"This is one of the few areas this year that hasn't had negative returns," said Sandra Manzke, chairman of Tremont Partners, a Rye, N.Y., arbitrage specialist.

The Merger Fund also has a very low-risk rating by traditional measures, suffering little of the volatility that can plague stock funds. But, as Don Phillips, publisher of the Morningstar Mutual Funds newsletter, notes: "The risks this fund are exposed to fly below the radar of the standard measures."

He added, "You ask a different set of questions about the Merger Fund than you ask about your typical equity fund -- the flow of deals, the percentage of returns from short-term capital gains, the research they have to do, the size of deals, the ability to hedge."

Still, the Merger Fund, which has positions in 45 deals, its top level ever, has managed those variables well enough to score only gains since its start in 1989, ranging from its lowest total annual return of 4.45 percent in 1992 to a high of 17.24 percent in 1993.

In only two of the last five years did it outperform its comparable group, as measured by the Lipper Capital Appreciation Fund Index. But the managers discourage comparison with the market because they are not betting the stock market will go up, only that mergers will be completed.

The fund limits market risk by hedging stock-for-stock acquisitions, offsetting purchases of the target company's shares with the short sale or optioning of acquirer's shares.

On July 6, for instance, the fund capped its position in AT&T's proposed takeover of McCaw, a one-for-one stock swap set to close Sept. 30, when it bought 25,000 McCaw shares at $51.125 each and shorted the same number of AT&T at $53.875. That locked in a spread of 5.4 percent, for an annualized return of 21.6 percent.

"The only risk in this position is the deal not happening," said Bonnie L. Smith, co-manager of the fund with Fredrick W. Green.

The fund tries to counter that risk in any deal with its research. Its sponsor, Westchester Capital Management Inc. of Valhalla, N.Y., was founded in 1980 as an arbitrage specialist, and the firm also manages two limited partnerships for very wealthy investors in a style similar to the fund's.

"Selectivity is one of the hallmarks to our approach to arbitrage," said Mr. Green, president of the fund and the management company.

He avoided investing in the biggest deal ever -- Bell Atlantic's $33 billion bid in October 1993 to acquire Tele-Communications Inc., which fell apart a few months later -- because, he said, "it was a very complicated transaction: a lot of regulatory issues were unresolved, we didn't have a definitive merger agreement and we were dealing with volatile personalities."

The fund did take "a small position" -- less than 2 percent of assets, said Mr. Green -- in Sterling Software's proposed acquisition of Knowledgeware for $120 million in stock announced last month. And it acknowledges losing money after Knowledgeware restated its 1994 results to a substantial loss and Sterling cut its offer to $72 million.

Mr. Green and Ms. Smith, have also bet boldly and won big.

For example, the fund did profit well last month after Wall Street had second thoughts about the proposed acquisition of Syntex by Roche Holdings. The $5 billion pharmaceuticals deal, announced in May, had been delayed by a Federal Trade Commission review, and Syntex shares tumbled as low as $20.50 in mid-August, far below Roche's offer of $24 a share cash.

But Mr. Green and Ms. Smith were confident Roche would prevail, and they raised the fund's position 25 percent, buying 50,000 shares near the low. Two weeks later, the FTC approved the acquisition and, said Mr. Green, "we made a huge return on the stock we bought at $22."

The Merger Fund, said Mr. Phillips, is "changing the definition of what a mutual fund is." But it faces the risk its arena could begin to empty as corporations' appetite and budget for acquisitions diminishes. Mr. Green said two trends make it unlikely, however, that merger activity will decline greatly as to limit the fund's opportunities.

The first is global competitiveness, prompting huge cross-border reorganizations like Syntex and Roche. The second is a trend toward consolidation in numerous U.S. industries.

One deal announced last week that does not interest the Merger Fund so far is the acquisition of Borden by KKR, to be bought with RJR Nabisco stock.

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