The Gabelli Approach to Merger Arbitrage Boasts Success
“Give a man a fish, and you feed him for a day. Teach a man to arbitrage, and you feed him forever,” is not only a clever play on words by none other than Warren Buffett, it is also a favorite of the management team at Gabelli. And with good reason.
Founded almost four decades ago, the Gabelli group of companies now manages approximately $34 billion in client assets across various equity and fixed income strategies. In addition to its renowned value investing strategies, Gabelli launched its first dedicated merger arbitrage strategy in 1985. For those unfamiliar with merger arbitrage, it centers around “deals,” which begin when a public company announces that it is being acquired by another company. A per-share purchase price is agreed upon by both parties that is above the current value of the stock of the company being purchased.
To take advantage of that differential, after the deal is announced, an arbitrage firm takes a position in the target company (i.e., the company being acquired). It purchases and builds a position in the target company at the market price (which is typically at a discount to deal terms) anticipating two things. 1. The deal will be completed, and 2. The target company and its shareholders will realize a profit when the “deal” closes at the announced purchase price–the profit being the difference between the deal price and the price at which the shares were initially purchased by the arbitrage investor.
The virtues of merger arbitrage generally include the potential for absolute, non-market correlated returns; unlike bonds or equity investments, which were both down double digits in 2022, arbitrage investing was up! In fact, as Michael Gabelli, son of Mario and a Managing Director at the firm, says, “In virtually any portfolio, merger arbitrage would be considered a good diversifier, because it generally has low volatility and is largely non-correlated to other risk assets.”
Simple enough, you might say. But many variables can “break” a deal, such as regulatory issues. And if the deal breaks, the stock price of the company being purchased may fall below that paid by the arbitrage investor.
So, how does Gabelli avoid these pitfalls? As Michael Gabelli puts it, “Ours is generally a risk averse and relatively conservative methodology. It’s always been a sophisticated strategy that requires a lot of research, expertise, and hedging, so not everyone can do it.”
He continues, “It is an intensive process to select the “right” deals and to figure out how to size a position and when to increase or decrease a position. Not to mention knowing which are the right types of deals, based off the merger agreements and other variables that may ultimately lead us to invest.”
And according to Michael Gabelli, “The style and the way we manage money is differentiated a bit from our competitors. Some may simply invest in “all deals,” or they may use leverage or more speculative strategies in their portfolios. We don’t do any of that. What we do centers around active portfolio management and in depth research backed by our firm’s research team.”
How effective is that approach? Since Gabelli began managing dedicated M&A portfolios 38 years ago, the S&P 500 has had 7 down years. Over the same period, Gabelli’s flagship M&A strategy has had just two down years on a net basis, and only one down year on a gross basis. Though past performance is no guarantee of future results, Gabelli notes that, while statistics indicate greater than 90% of deals do not break, approximately 99% of deals in their portfolio have been successfully completed, thereby illustrating the advantages of taking an active investment approach to narrow the pitfalls of deals breaking.
Summing up, Michael Gabelli says, “Our approach is truly risk-averse and, because returns in the strategy depend solely on deals closing, it is absolute return oriented.” And as can be seen, they have the hard data to prove it.
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