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Recent M&A Activity Bodes Well For Merger Funds

By Staff Writer

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Nov. 19, 2004 — Prospects for funds that focus on mergers look good right now, observers say, because after a dry spell during the last three years, announced corporate takeovers and buyouts have picked up in recent months.

Through November 9th, 6,891 acquisitions valued at $609.3 billion had been announced, according to Thomson Financial. To put that in perspective, 7,579 deals valued at $538.1 billion were disclosed in all of 2003. A year earlier 6,920 deals worth $433.5 billion were announced. On Wednesday, Kmart agreed to buy Sears for $11.5 billion.

The increased activity enables fund managers to “cherry pick among the very best deals that are out there,” explains Regina Pitaro, a managing director with Gabelli Asset Management, which oversees the Gabelli ABC (GABCX) and the Enterprise Grp Mergers & Acquisitions Fund/A (EMAAX).

The faster pace of merger activity led Gabelli Asset Management to reopen the ABC Fund to new investors earlier this year. It had been closed since early 1992. The Enterprise fund is also accepting new investors.

In terms of their ability to generate positive returns, funds that look to profit from mergers and acquisitions have largely been successful. As a group, they have almost always been in the black over the short and long runs, recording slow and steady gains with low volatility.

Gabelli ABC has never had a losing year since its inception in 1994. The Enterprise fund was down in its inaugural year in 2002, but has been up since. “These are basically absolute return oriented. They try to make money in up markets and down markets,” said Mario Gabelli, who oversees both funds.

The 10-year-old Merger Fund (MERFX) lost money only in 2002, and the Arbitrage Fund/R (ARBFX), which opened its doors in 2001, has never ended a year in the red. Both funds, which are currently closed to new investors, were in negative territory this year through October.

The Gabelli and Enterprise funds and their two competitors engage in merger arbitrage, an investment strategy that tries to profit from the successful completion of publicly disclosed acquisitions. Since they’re tied to deals, results of these types of funds are not correlated to broad market gauges like the S&P 500. In addition, they’re less volatile than the overall market, and can help diversify individual portfolios, observers say.

Although the Gabelli and Enterprise funds are both run by Mario Gabelli, their portfolio composition differs, Pitaro notes. Both invest in announced deals, U.S. Treasurys and cash. But the Enterprise fund, she explains, can hold up to a third of its assets in companies that are judged to be potential acquisition targets, although they have not yet been bid for. Those investments are aimed at boosting returns, she says.

While these funds may hold advantages over general diversified equity funds, there are potential drawbacks to investing in them, says Rosanne Pane, chief mutual fund strategist for Standard & Poor’s. (She is also a shareholder in the Enterprise Mergers & Acquisitions Fund.)

“If you believe that the environment is going to be favorable” for mergers and acquisitions, “then this is a good type of fund to invest in,” she says. “But you also have to realize that when corporations are pessimistic about the future, there’s very little of this type of activity.”

In those instances, shareholders may end up with a fund that has a sizable chunk of its assets in cash while its manager continues to collect a fee for running the fund, Pane said. (Indeed, Gabelli ABC Fund last recorded cash holdings were at 77.2% of assets as of September.) She recommended that investors commit no more than 5% of their assets to merger funds.

Merger Funds

Year-to-Date Return Through 10/29/2004 (%)

Three-Year Annualized Return Through 10/29/2004 (%)

Five-Year Annualized Return Through 10/29/2004 (%)

Expense Ratio (%)
Arbitrage Fund/R (ARBFX)

-3.5

+8.1

NA

1.95
Enterprise Grp Mergers & Acquisitions Fund/A (EMAAX)

+1.9

+5.8

NA

1.76
Gabelli ABC (GABCX)

+0.9

+2.5

+4.7

0.65
Merger Fund (MERFX)

-0.4

+1.1

+5.1

1.37

Source: Standard & Poor’s. Total returns include reinvested dividends. Data as of 10/29/04.

Contact Bob Keane with questions and comments at: [email protected].