The Wall Street Journal is running an article (subscription required) today observing the anemic recent returns of merger arbitrage funds. This is surprising, according to the article, because of the high number of deals tumbling in. Last year was the most prolific since 2000.
The article quotes Mario Gabelli, manager of the scintillatingly named "Gabelli ABC Fund" thus: "Investors should think about this as an enhanced money-market return." So much for an investment class that used to pull out 30+% annualized returns in the 1980s. Of course, that was back when Ivan Boesky and company could boost returns by getting long on a target with huge leverage before the market was aware a deal was in the works. I would love to see an analysis of the returns on an insider trading strategy.
So what keeps spreads (and therefore merger or risk arbitrage returns) so low?
One explanation is that we are seeing more "mergers of equals" and therefore the lack of price disparity and low spreads between such firms are more limited to begin with. Lower spreads, lower returns.
Another explanation is that the funds investing in merger arbitrage opportunities all have effectively the same criteria and therefore invest in the same deals leaving less of a spread. In other words, merger arbitrage is "oversubscribed."
A third explanation is that markets are getting more efficient. They "sense" a deal before it emerges and price up targets.
A subset of this third explanation is that there is a clever and well funded insider trading network at work within the market and they are squeezing returns out of the law-abiding risk arbitrage gang. Since this last option is the most conspiracy oriented it is also my favorite.
Of course, there is a long history of claiming that insider trading actually makes for more efficient markets. Interested readers might start with Stephen M. Bainbridge's Florida Law Review Article, "The Insider Trading Prohibition: A Legal and Economic Enigma." (True Gekkoists will want to ignore the fact that it was printed back in 1986).
