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2.13.2018

Volatility and the Illusion of Diversification

As we observe recent market events, what is extraordinary to us is not the sharp rise in volatility over the past couple weeks, but rather the extended periods of subdued volatility over the previous eight years. We don’t know if this marks the beginning of a “new normal.” We don’t pretend to know the future direction of the equity markets, or whether bond yields have begun an inexorable path upwards, or even whether volatility will remain at elevated levels. However, what the past fortnight has reminded us of is that volatility is a mean reverting asset, and reversion to the mean can have unexpected consequences.

It is not just investors who shorted the fear gauge through inverse VIX exchange traded funds or through option volatility mutual funds who had a brutal awakening. Many investors were likely surprised (and disappointed) to observe correlations converge across the breadth of their investments. This phenomenon where different asset classes – stocks, bonds, real estate and alternative investments – all lose value to some degree at the same time is commonly referred to as “short volatility.” In fact, our research indicates the majority of asset classes lose value when volatility rises. This raises the inevitable question: what type of portfolio will be able to withstand the impact of spikes in volatility and preserve capital?

At Water Island Capital, we have analyzed the historical data across various investment strategies with the goal of identifying those asset classes that have demonstrated resilience in withstanding large drawdowns from the re-pricing of risk. Our work indicates that while many alternative investments will likely fail to protect when markets become more volatile, there is a subset of strategies, including Merger Arbitrage, Market Neutral and Managed Futures, that can potentially protect against capital loss and deliver sustainable diversification benefits, regardless of the volatility environment.

In today’s environment, we believe our research paper on this phenomenon (“Short Volatility and the Illusion of Diversification”) is particularly relevant. If you would like to learn more, please click here to access the paper.

The "VIX," also known as the CBOE Market Volatility Index, is an index that is commonly used as a measure of domestic equity market volatility.

Past performance is not indicative of future results.

2.7.2018

Over the past few trading days we have witnessed a spike in volatility that caught many market watchers off guard, with the CBOE Market Volatility Index, aka the “VIX,” having closed above 20 for the first time since November 2016. The market sell-off was largely a reaction to fears of rising inflation and the potential for interest rates to rise more quickly than expected, and it has caused some investors to review their portfolios and reset their near-term expectations for global equity markets.

We at Water Island Capital are always cognizant of the volatility environment. Volatility can be one of the drivers of returns for event-driven investment strategies, and we believe that for a prudent and prepared investor, bouts of volatility can serve more as opportunity than as misfortune. With that said, how has this recent shake-up in the market impacted our strategies, and how are we reacting?

  • Large scale market movements have resulted in derisking by market participants across the board. This has led to wider spreads in certain transactions and better profit opportunities across event-driven strategies, most specifically merger arbitrage.
  • Entering 2018 our expectations for renewed volatility and a market pullback drove our decision to maintain above-average cash levels. This “dry powder” has allowed us to take advantage of opportunities across the event landscape. We’ve added capital to our highest conviction ideas at attractive entry points, effectively enhancing the portfolios’ potential return profile.
  • In our merger arbitrage strategy, there have been some mark-to-market impacts to specific deals as spreads have widened, but we believe that these will be among the first to recover given the definitive contracts that are in place.
  • Importantly, our sizing and positioning procedures during volatile periods follow the exact same processes utilized during normalized market conditions: we continue to focus on high conviction, strategic, definitive situations.
  • In managing our portfolios, we attempt to reduce or eliminate short-volatility exposure, with the goal of generating a market neutral stance that can endure the types of conditions that we’ve witnessed over the past few days.

 

In our communications with clients, we have consistently emphasized how interest rates and volatility can drive returns for spread-based strategies such as merger arbitrage. Given the recent trends in these areas, we believe the marketplace is moving in a direction that can prove beneficial for our event-driven strategies and, ultimately, our clients.

Spreads, or deal spreads, refers to the difference between the price at which a target company’s shares currently trade, and the price an acquiring company has agreed to pay. Mark-to-market refers to the valuation of investments based on current market values. To derisk means to take steps to make something less risky or less likely to involve a financial loss, and frequently involves exiting or reducing positions. The CBOE Market Volatility Index, or VIX, is an index that is commonly used as a measure of domestic equity market volatility.

1.31.2018

The recent passage of the new U.S. tax code has confirmed our optimism for event-driven opportunities in 2018. Corporate management and boards have greater clarity around taxes, and we believe the decrease in the corporate tax rate from 35% to 21%, coupled with a one-time tax on the repatriation of foreign cash to the US, will lead to increased corporate activity.

A trend is beginning to emerge in the biotech space as recent transactions were announced with very large premiums. Celgene paid a 91% premium for its acquisition of Juno Therapeutics while Sanofi paid a 64% premium for its acquisition of Bioverativ. Despite sound, stable buyers, these deal premiums have led to high initial deal spreads as pre-announcement holders are less sensitive to selling and booking a profit (given the massive run-ups in these stocks).

We have also seen robust activity of “strategic alternatives” for companies such as Xerox, Microsemi Corp., and Akamai. These situations may develop into compelling special situation opportunities including speculative mergers and acquisitions, spin-offs, assets sales, and debt repurchases.

Please click here to view the most recent top ten holdings for each of our funds.

1.30.2018
Introducing more frequent market commentary from Water Island Capital

Since 2000, the Arbitrage Funds – advised by Water Island Capital – have been a pioneer in offering event-driven investment strategies in a mutual fund format. Coupled with our longstanding track record, our singular focus on catalyst-driven investing places us in a prominent position to share our observations on this segment of our industry. As such, we are pleased to announce that we will be publishing more frequent market commentary to the Updates section of our website. In publishing our thoughts in a more frequent manner, our goal is to provide timely updates on issues impacting the event-driven sector and to provide our audience with information that may help them navigate the current market. If you would like to receive this commentary directly in your inbox, we encourage you to subscribe to our mailing list.

12.15.2017
Arbitrage Funds 2017 Year-End Distributions

The Arbitrage Funds will be making the following year-end distribution payments for 2017 with a record date of 12/13/17, an ex-dividend/reinvest date of 12/14/17, and a payable date of 12/15/17:

THE ARBITRAGE FUND
Institutional (ARBNX) Retail (ARBFX) C Share (ARBCX) A Share (ARGAX)
Ordinary Income $0.13303 $0.08743 $0.00129 $0.10422
Short-Term Capital Gain $0.27948 $0.27948 $0.27948 $0.27948
Long-Term Capital Gain $0.08402 $0.08402 $0.08402 $0.08402
Total $0.49653 $0.45093 $0.36479 $0.46772
THE ARBITRAGE EVENT-DRIVEN FUND
Institutional (AEDNX) Retail (AEDFX) C Share (AEFCX) A Share (AGEAX)
Ordinary Income $0.05862 $0.02576 $0.00000 $0.02877
Short-Term Capital Gain $0.00000 $0.00000 $0.00000 $0.00000
Long-Term Capital Gain $0.00000 $0.00000 $0.00000 $0.00000
Total $0.05862 $0.02576 $0.00000 $0.02877
THE ARBITRAGE CREDIT OPPORTUNITIES FUND
Institutional (ACFIX) Retail (ARCFX) C Share (ARCCX) A Share (AGCAX)
Ordinary Income $0.04757 $0.02437 $0.00000 $0.04477
Short-Term Capital Gain $0.00000 $0.00000 $0.00000 $0.00000
Long-Term Capital Gain $0.00000 $0.00000 $0.00000 $0.00000
Total $0.04757 $0.02437 $0.00000 $0.04477
THE ARBITRAGE TACTICAL EQUITY FUND
Institutional (ATQIX) Retail (ATQFX) C Share (ATQCX) A Share (ATQAX)
Ordinary Income $0.00000 $0.00000 $0.00000 $0.00000
Short-Term Capital Gain $0.00000 $0.00000 $0.00000 $0.00000
Long-Term Capital Gain $0.00000 $0.00000 $0.00000 $0.00000
Total $0.00000 $0.00000 $0.00000 $0.00000
11.17.2017
Arbitrage Funds 2017 Year-End Distribution Estimates

The Arbitrage Funds will be making year-end distribution payments for 2017 with a record date of 12/13/17, an ex-dividend date of 12/14/17, and a payable date of 12/15/17. As of 10/16/17, the estimated distribution amounts are as follows:

THE ARBITRAGE FUNDS – 2017 DISTRIBUTION ESTIMATES
Ordinary
Income
Short-Term
Capital Gain
Long-Term
Capital Gain
Total
Arbitrage $0.1012 $0.2256 $0.0594 $0.3862
Arbitrage Credit Opportunities $0.0290 $0.0000 $0.0000 $0.0290
Arbitrage Event-Driven $0.0929 $0.0000 $0.0000 $0.0929
Arbitrage Tactical Equity $0.0107 $0.0000 $0.0000 $0.0107

The information provided is an ESTIMATE and is subject to change.

11.9.2017
AT&T/Time Warner - Notes from the Desk

Recent news regarding ongoing negotiations between AT&T and the US Department of Justice has led to volatility in the company's proposed acquisition of Time Warner over the past week. For more information on what is happening and our thoughts on the prospects for the deal, please visit our Research page to access an update from our investment team.

8.17.2017
Recent Volatility in Merger Arbitrage

Some investors have witnessed an increase in the volatility of broad merger arbitrage returns over the past few weeks. Visit our Research page to access a piece with our investment team's thoughts on the primary drivers behind this phenomenon.

12.15.2016
Arbitrage Funds 2016 Year-End Distributions

The Arbitrage Funds will be making the following year-end distribution payments for 2016 with a record date of 12/14/16, an ex-dividend/reinvest date of 12/15/16, and a payable date of 12/16/16:

THE ARBITRAGE FUND
Institutional (ARBNX) Retail (ARBFX) C Share (ARBCX) A Share (ARGAX)
Ordinary Income $0.00000 $0.00000 $0.00000 $0.00000
Short-Term Capital Gain $0.11374 $0.11374 $0.11374 $0.11374
Long-Term Capital Gain $0.00909 $0.00909 $0.00909 $0.00909
Total $0.12283 $0.12283 $0.12283 $0.12283
THE ARBITRAGE EVENT-DRIVEN FUND
Institutional (AEDNX) Retail (AEDFX) C Share (AEFCX) A Share (AGEAX)
Ordinary Income $0.00000 $0.00000 $0.00000 $0.00000
Short-Term Capital Gain $0.00000 $0.00000 $0.00000 $0.00000
Long-Term Capital Gain $0.00000 $0.00000 $0.00000 $0.00000
Total $0.00000 $0.00000 $0.00000 $0.00000
THE ARBITRAGE CREDIT OPPORTUNITIES FUND
Institutional (ACFIX) Retail (ARCFX) C Share (ARCCX) A Share (AGCAX)
Ordinary Income $0.09550 $0.08815 $0.06862 $0.08828
Short-Term Capital Gain $0.00000 $0.00000 $0.00000 $0.00000
Long-Term Capital Gain $0.00000 $0.00000 $0.00000 $0.00000
Total $0.09550 $0.08815 $0.06862 $0.08828
THE ARBITRAGE TACTICAL EQUITY FUND
Institutional (ATQIX) Retail (ATQFX) C Share (ATQCX) A Share (ATQAX)
Ordinary Income $0.00000 $0.00000 $0.00000 $0.00000
Short-Term Capital Gain $0.00000 $0.00000 $0.00000 $0.00000
Long-Term Capital Gain $0.00000 $0.00000 $0.00000 $0.00000
Total $0.00000 $0.00000 $0.00000 $0.00000
11.21.2016
Arbitrage Funds 2016 Year-End Distribution Estimates

The Arbitrage Funds will be making year-end distribution payments for 2016 with a record date of 12/14/16, an ex-dividend date of 12/15/16, and a payable date of 12/16/16. As of 10/31/16, the estimated distribution amounts are as follows:

THE ARBITRAGE FUNDS – 2016 DISTRIBUTION ESTIMATES
Ordinary
Income
Short-Term
Capital Gain
Long-Term
Capital Gain
Total
Arbitrage $0.069664 $0.245375 $0.024261 $0.339300
Arbitrage Credit Opportunities $0.039116 $0.000000 $0.000000 $0.039116
Arbitrage Event-Driven $0.000000 $0.000000 $0.000000 $0.000000
Arbitrage Tactical Equity $0.000000 $0.000000 $0.000000 $0.000000

The information provided is an ESTIMATE and is subject to change.