The Arbitrage Funds
Advised by Water Island Capital


Notes from the Desk

News & Commentary from Water Island Capital

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The Arbitrage Funds Announce the Appointment of Two New Trustees to Fund Board

New York, New York, Oct. 31, 2018 – The Arbitrage Funds is pleased to announce the appointment of two new trustees, Nancy M. Morris and Christina Chew, to our fund board, effective immediately.

Nancy Morris brings over 30 years of leadership experience in government and the investment management industry. She served as Secretary of the Securities and Exchange Commission and Deputy Chief Counsel of the Division of Investment Management. Her industry experience includes some of the largest asset management and mutual fund firms, including Wellington Management Company, T. Rowe Price, and Allianz Global Investors. Nancy also chaired the Investment Company Institute (ICI) Chief Compliance Officer Committee and served on the ICI’s Liquidity Rule Implementation Working Group. Ms. Morris received a JD from the University of Idaho and a BA from Hartwick College.

Christina Chew is a seasoned investment management professional who joined Water Island Capital, advisor to The Arbitrage Funds, in 2013. In addition to now serving on The Arbitrage Funds trust board, she serves as Senior Managing Partner of Water Island Capital where she has management oversight responsibility for client service and marketing, risk and operational infrastructure, capital raising functions and accounting and administration. She is also responsible for firm-wide strategic planning and new product development. Ms. Chew received an MBA from The Wharton School, an MA from the University of Pennsylvania, and a BA from Columbia College.

Founder of Water Island Capital and Chairman of The Arbitrage Funds Trust, John S. Orrico, stated, “We are delighted that Nancy and Christina are joining our fund board. Both individuals bring unique perspectives and deep experience that will enhance our board discussions. In addition, our board strongly believes that diversity drives better decision making. The appointment of Nancy and Christina will complement the diversity of The Arbitrage Funds’ board – which will benefit our shareholders.”

With the appointment of Mss. Morris and Chew, The Arbitrage Funds' board consists of 7 members, including: John S. Orrico, Founder & Chief Investment Officer of Water Island Capital; John C. Alvarado, CFO of Magnum Development LLC; Robert P. Herrmann, President & CEO of Discovery Data; Stephen R. Byers, Independent Director and Consultant; and Francis X. Tracy, former President, Chief Financial Officer, Treasurer, and Secretary for Batterymarch Financial Management.

About The Arbitrage Funds

The Arbitrage Funds (the “Trust”) is a Delaware statutory trust, which was organized on December 22, 1999, and is registered under the Investment Company Act of 1940, as amended (the “1940 Act”) as an open-end management investment company. The Trust currently offers four series of shares to investors, The Arbitrage Fund, The Arbitrage Event-Driven Fund, The Arbitrage Tactical Equity Fund and The Water Island Credit Opportunities Fund (formerly The Arbitrage Credit Opportunities Fund) (each a “Fund” and, collectively, the “Funds”). For more information, please visit

Arbitrage Funds 2018 Year-End Distribution Estimates

The Arbitrage Funds will be making year-end distribution payments for 2018 with a record date of 12/12/18, an ex-dividend date of 12/13/18, and a payable date of 12/14/18. As of 10/15/18, the estimated distribution amounts are as follows:

Capital Gain
Capital Gain
Arbitrage $0.123104 $0.129271 $0.020827 $0.273202
Arbitrage Event-Driven $0.092622 $0.000000 $0.000000 $0.092622
Arbitrage Credit Opportunities $0.026816 $0.000000 $0.000000 $0.026816
Arbitrage Tactical Equity $0.059313 $0.000000 $0.000000 $0.059313

The figures above are preliminary estimates. Given the nature of the funds' strategies, these estimates are highly likely to change, and may potentially change dramatically, before figures are finalized at year-end. Distribution estimates calculated as of 10/15/18. Estimates are calculated at the fund level — final distribution numbers may vary by share class.

Water Island Capital
Update on Recent Market Volatility

October commenced with the return of heightened volatility in the markets, with the CBOE Volatility Index breaching 20 for the first time since April and the S&P 500 experiencing a 6.7% decline from October 2-11. The rapid sell-off was exacerbated by the growth in exchange-traded funds, factor models, risk parity funds, and commodity trading advisors, and increasing correlation between asset classes indicates a risk-off mentality is prevailing amongst investors.

The foundation for this largescale recalibration of prices began on September 26, after the Federal Reserve decided to once again raise interest rates amid strong economic data and positive consumer confidence. At the time, investors chose to de-emphasize the impact of potential tariffs on corporate earnings, and inflation expectations remained subdued. Yet on October 3, Federal Reserve Chairman Jerome Powell suggested rates are a “long way” from neutral, setting expectations for another rate hike in December (and several more in 2019), and Amazon announced it would raise the minimum wage for all its employees to $15 per hour, rekindling inflationary fears. Furthermore, Ford guided earnings downward, citing increased costs due to tariffs. The combination of higher rates and potentially lower earnings left many investors uncertain about where equities should trade, and in the face of volatility many simply opted to sell.

In the face of market volatility, event-driven strategies have held up reasonably well. Our outlook for the months ahead remains positive, with a healthy universe of catalyst-driven opportunities to select from. Over the past week, several definitive merger transactions were announced – including the stock-for-stock acquisition of Rowan Companies PLC by Ensco PLC, GFL Environmental acquisition of Waste Management Industries, and TransDigm’s all-cash acquisition of Esterline Technologies. Merger arbitrage spreads for straightforward, fully financed transactions have held steady, while longer-dated deals and transactions requiring approval from the Committee on Foreign Investment in the United States or China’s State Administration for Market Regulation widened during the sell-off. Spin-off activity also remains on track. We expect during Q4 to see the completion of several high-profile spin-offs including Resideo Technologies from Honeywell, Equitrans Midstream from EQT Corp, and Arcosa Inc from Trinity Industries.

In the credit space, selling by high yield ETFs along with ETF arbitrage activity has caused a more pronounced sell-off in the more liquid part of the market (i.e., those bonds eligible for inclusion in ETFs). This has permitted bond investors who are unconstrained by benchmarks to outperform indices and peers. We also continue to see private equity (PE) firms driving new transactions. The deals either involve public companies being taken private or PE firms purchasing privately-held assets or companies. Both situations present investment opportunities for catalyst-driven credit investors. Even with general selling in high yield, we still see credit spreads near the tightest levels in the past five years. While this may be warranted due to positive economic activity and low default rates, we think a flatter credit curve has created good short-duration opportunities for investors without the need to take excessive duration risk.

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Deal Update: The Battle for Sky

This past weekend, we witnessed the end of a protracted bidding war for one of the premier telecommunications companies in the UK – Sky plc. Sky is a provider of internet and pay television broadcasting services including news, movies, sports, and pay-per-view events. The fight to acquire the company is one of the more interesting merger situations in which we have been involved lately, and it concluded with a rather uncommon mandatory auction process in the UK.

UK takeover code is unique in that strict requirements are outlined which can dictate the timeline of a deal and the actions of an acquirer. Our team in London has decades of combined experience in UK and European markets, putting us in a strong position to understand the intricacies of this jurisdiction. For example, if a person or group acquires more than 30% of the voting interest of a company, they must make a cash offer to all other shareholders at the highest price paid in the 12 months before the offer was announced. The “Put Up or Shut Up” rule, which was designed to prevent UK companies from facing the prolonged threat of a hostile takeover, can require a company to make a binding offer within 28 days, or be forced to walk away for six months. UK-based deals go “riskless” in their final weeks once certain closing conditions are met, as the acquirer is then legally bound to complete the transaction. Yet another interesting component of UK takeover code is the auction process that is enacted in a competitive bidding situation, which was triggered in the battle for Sky.


The saga began in December 2016 when Fox – the US-based television and film company, which already owned 39% of Sky – offered to acquire the remaining 61% of the company for $23 billion. (Notably, this was not Rupert Murdoch’s first attempt to acquire Sky. Six years prior, News Corp – of which Fox was a part at the time – abandoned a bid for Sky amidst a phone-hacking scandal at one of its UK-based newspaper holdings, which made the deal politically untenable.)

In December 2017, while Fox’s acquisition of Sky was still undergoing regulatory review, Fox entered into a definitive agreement to sell its entertainment assets – including its existing Sky stake – to Disney for $52 billion. This eventually led to two separate bidding wars involving Comcast. First, Comcast made a rival offer for Sky (at £12.50 per share, 16% above Fox’s bid) in February 2018. Second, Comcast challenged Disney with a topping bid for Fox, offering $65 billion in June 2018.

In July, several developments unfolded. On July 11, Fox (with permission from Disney) raised its offer for Sky from £10.75 to £14 per share – only to be outbid by Comcast yet again, which offered £14.75 per share later that same day. Later that month, on July 19, Comcast abandoned its pursuit of Fox in order to focus its efforts on Sky, after Disney increased its offer to $71.3 billion.

The Auction

Since neither Fox’s nor Comcast’s offer for Sky were deemed “best and final,” a competitive situation as defined in the UK takeover code continued to exist. In situations like this and in order to provide an orderly framework, the UK takeover panel conducts an auction process with the relevant parties in which both parties are able to provide their best and final offers for the company. The UK takeover panel and the parties agreed to hold an auction process on September 22, consisting of a maximum of three rounds. In the first round, only the bidder with the lowest offer (Fox) was allowed to make an increased bid. In the second round, only the bidder that was not eligible to make an offer in the first round (Comcast) was allowed to make an increased bid. If the auction was not concluded after the second round (i.e., if Comcast increased its bid in round two, thus extending the auction), there would be a final round, in which both bidders may make an increased final offer.

The auction went the distance, with both Comcast and Fox increasing their offers and making their best-and-final bids in round three. The final price Fox offered (with permission from Disney) was £15.67, and the final price Comcast offered was £17.28. Under UK takeover code, neither of these offers could be re-raised, and the prices were published by the UK takeover panel on the evening September 22. Ultimately, Comcast’s final bid represented a 60% increase over Fox’s original offer from December 2016.

What’s Next?

While Comcast’s offer is clearly superior to Fox’s, it stipulates a 50% acceptance condition. Fox had publicly stated it was still assessing its options regarding its existing 39% ownership stake. If Fox decided to maintain its stake, Comcast would have needed an 82% acceptance rate across the rest of the shareholder base to be successful in taking control of Sky. (While we believed this was achievable given the superiority of Comcast’s offer, some risk of slippage nonetheless remained. Subsequently, news emerged that Comcast had acquired over 30% of Sky on the open market and that Fox – with permission from Disney – had decided to sell its stake to Comcast, thus satisfying the acceptance condition and helping the transaction move closer to wholly unconditional as per UK takeover code.) We continue to monitor the position and will look to re-add in the event we are able to capture an appropriate spread to the final deal terms.

Water Island UK, Ltd. Is a wholly-owned subsidiary of Water Island Capital, LLC. View top ten holdings.

commentaryWater Island Capital
August 2018: Notes from the Desk

Mergers & Acquisitions (M&A)

With $1.17 trillion of M&A announced by US firms year-to-date, 2018 remains on track to surpass 2015's record-setting volumes. Despite headlines related to global trade disputes, we have seen several large and significant transactions announced over the past few weeks across various industries. In the Real Estate Investment Trust (REIT) space, Brookfield Asset Management announced that it will acquire Forest City Realty Trust for $25.35 in cash per share. The trend towards REIT deals has been triggered by selling in the sector that has pushed many REITs to trade at discounts to their net assets values. We expect this trend will continue. In healthcare, RegionalCare Hospital Partners, owned by Apollo Global Management, entered into a definitive agreement to acquire LifePoint Health for $65 per share. In chemicals, Platform Specialty Products (PAH) agreed to sell its Arysta LifeScience division to UPL Ltd for approximately $4.2 billion in cash. Proceeds from the deal are expected to be used to pay down debt at PAH. Banking consolidation also appears to be accelerating as rising short-term rates and softer regulatory hurdles for community and regional banks benefits the sector. Most recently, FCB Financial Holdings agreed to be acquired by Synovus in a stock-for-stock deal. The transaction was valued at approximately $2.7 billion.

Overall, transactions that require regulatory approval from the Committee on Foreign Investment in the US (CFIUS) or China’s State Administration for Market Regulation (SAMR), such as Rockwell Collins/United Technologies, 21st Century Fox/Disney, and XL Group/AXA, are leading to wider deal spreads. The lack of clarity on the process and the difficulty in assessing political risks have weighed on these deals.

Despite regulatory headwinds that recently impacted some large deals (Time Warner/AT&T, Tribune/Sinclair Broadcasting), The New York Post reported “US regulators believe three national 5G wireless providers are needed to ensure robust competition. … After studying the Sprint-T-Mobile proposal for more than three months, the Department of Justice [DOJ], while not yet making a decision on the merger, now believes three carriers are needed to establish a true competitive marketplace, according to a source with direct knowledge of the thinking within the DOJ.” While this deal isn’t likely to be assessed until 2019, it will attract attention given the level of investor ownership in both the stocks and bonds of the companies involved.

Lastly, the Wall Street Journal recently published an article entitled How Investors Can Cash In on the M&A Boom (subscription required). The piece highlights the use of merger arbitrage funds as a way to capitalize on the rise in merger and acquisitions, and notes that a rising interest rate environment could lead to more favorable deal spreads.


Last week, Jamie Dimon, Chairman and CEO of JPM Chase, made headlines when he noted that investors should be prepared for a 5% 10-year yield. While Dimon’s comment did not contain any suggestion of a timeframe to reach such a yield, it certainly highlighted a known tail risk in the market.

Even prior to Dimon’s weekend comments, fixed income investors were concerned about rising interest rates, particularly amid solid US economic growth and the prospect of inflation. The primary solution for cautious fixed income investors has been to increase allocations to floating rate products, such as levered loans, or to invest in short-duration credit as higher short-term rates appear more compelling relative to longer-term yields. Consequently, flows to levered loan and short-duration funds has risen during 2018, and levered loans have outperformed high yield bonds year-to-date.

Investor demand for floating rate bank loans provided cheaper financing for many companies, but lending standards have weakened in the process. Since June, the trend toward loan issuance has taken a pause as investors push back on terms. This has pushed issuers to tap the high yield bond market again for capital, but the excess supply could create a negative impact on credit spreads. This could ultimately lead to opportunities to purchase new issues bonds with more attractive terms.

We think both the levered loan and high yield bond markets will remain active in the near-term as private equity (PE) funds have plentiful cash reserves, evidenced by KKR’s purchased of BMC Software and Envision Healthcare, Apollo’s purchase of Lifepoint Healthcare, and various smaller PE acquisitions including Mitel, Essendant, and

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