Merger arbitrage investors are typically involved in the
purchase of a company’s stock that is to be acquired and
the corresponding short sale of the acquiring company’s
stock. Detailed analysis is performed in order to
estimate the probability of the “deal” closing, the
price at which it will close, the time it will take to
close, and any other regulatory risks that may apply.
Merger arbitrage Investment Advisors are involved in
both stock for stock deals and cash for stock deals.
Merger arbitrage Investment Advisors vary widely in
their use of leverage and cash.
Distressed securities investing involves the purchase
and/or sale of publicly traded securities involved in
bankruptcy or reorganization. Distressed investors will
invest in different phases of bankruptcy. Typically, the
phases are pre-bankruptcy, bankruptcy, and
post-bankruptcy. Investors will often utilize the
spectrum of securities within a firm’s capital
structure. Those securities are, listed in terms of
risk, as follows: equities, trade creditor claims,
junior unsecured public debt, senior unsecured public
debt, senior secured public debt, and senior secured
private debt. Investors also differ in their willingness
to take “control” or “blocking” positions in the
companies they are buying.
Long biased Investment Advisors will have net market
exposure (gross longs minus gross shorts) greater than
zero. These Investment Advisors tend to believe, that
over time the equity markets appreciate. Therefore, they
prefer to hove long exposure to the equity
markets. Long biased Investment Advisors do realize,
however, that there is ample opportunity to profit from
the short sale of overvalued equities. Long biased
managers vary greatly in their net exposure. The
commonly utilized “Jonesian” approach allows for net
exposure ranging from 40-70%.
Opportunistic Investment Advisors will vary their
exposure from net long to net short depending upon their
market outlook. Opportunistic strategies can become
rather concentrated in certain economic sectors,
capitalization ranges, or investment styles depending on
the opportunities that present themselves.
Relative value hedging in convertible bonds primary
involves long positions in convertibles or warrants and
short positions in the underlying stock in an effort to
capitalize on relative pricing inefficiencies.
Convertible and warrants are priced as a function of the
price of the underlying stock, expected future
volatility of returns, risk free interest rates and, in
the case of convertibles, the issue-specific
corporate/Treasury yield spread. In certain cases, these
instruments are not hedged directly with the underlying
stock, but rather with an index.
Fixed income arbitrage involves the identification and
exploitation of mispricing in the bond markets. In the
active and competitive U.S. bond markets large relative
mispricings are rather uncommon. Therefore, Investment
Advisors will often utilize leverage to further benefit
from small pricing errors.
Statistical arbitrage Investment Advisors utilize a
quantitative, or “black box,” approach to investment
management. Complex mathematical tools are used to
identify statistically significant mispricings in
stocks, bonds, currencies, and/or commodities. Once
identified, Investment Advisors trade to exploit the
momentary pricing aberrations. In order to fully exploit
the limited opportunities available, leverage and rapid
computer enhanced trading techniques are often involved.
Market Neutral Equity
Market neutral equity arbitrage is a broad investment
style that can involve a number of sub-strategies.
Market neutral Investment Advisors are seeking to
generate consistent absolute returns independent of the
broader equity markets. Investment Advisors invest both
long and short and will typically match their longs and
shorts so that the portfolio is 0% net long on either a
dollar-weighted or beta-weighted basis.
Short selling Investment Advisors sell short equities
based upon fundamental analysis in an effort to profit
from declining equity prices. An allocation to short
selling Investment Advisors is typically utilized as a
hedge against the natural long bias of certain