You don’t usually think of mutual funds when you are looking for alternative investments. But two mutual funds that do employ hedge fund-style trading strategies are the 14-year-old Merger Fund (MERFX), profiled in IA in December 2001, and its younger competitor, the Arbitrage Fund (ARBFX), launched in 2000 by money manager John Orrico. Both invest in announced mergers, often buying the target company and selling the acquirer short. But while the $800 million Merger Fund’s impressive long-term winning streak has cooled lately, the tiny ($85 million) Arbitrage Fund (www.thearbfund.com) has been going strong, gaining about 9% in 2001 and again in 2002, and another 2% through March 31. That’s despite a merger market that has slowed from the torrid pace of a few years ago.
Orrico formerly was senior analyst on a team running a $100 million arbitrage portfolio for Wall Street’s Gruss family, which he says prized “capital preservation and sensible returns–four times the Treasury bill rate.” Orrico avoided leverage then, unlike many merger arb hedge fund types, and still eschews borrowing to juice up returns. His philosophy has changed little since he went out on his own. “I do great versus the S&P,” he says, “when the S&P is having a lousy year.”
While he has played a number of megamergers, including Pfizer and Pharmacia, Orrico is focusing much of his effort on smaller “niche acquisitions” in software, telecommunications, biotechnology, and finance–while shunning takeovers involving restaurateurs, movie theater chains, and highly indebted companies.
Before he jumps into a deal, Orrico typically will check Wall Street analysts, Securities & Exchange Commission filings, credit research services, and even a team of lawyers in hopes of finding surprises that could bust up a merger. Indeed, he estimates that 3% of the deals he has been involved in have broken apart, including two last September alone. That’s why he prefers to limit his exposure in any one deal to no more than 5% of his portfolio.