The Arbitrage Funds

Frequently Asked Questions

  1. Who is the advisor to The Arbitrage Fund?
  2. What is your long-term mission?
  3. What are some of the major events in Water Island Capital’s evolution over time?
  4. How have the Arbitrage Fund’s management team, process, or philosophy evolved over time?
  5. Has the Arbitrage Fund experienced “style drift” due to changes in strategic composition or geographic exposure?
  6. How has international geographic exposure contributed to recent returns?
  7. How has the Arbitrage Fund evolved in terms of market capitalization exposure over time?
  8. How have Arbitrage Fund shareholders benefited from the growth in assets under management at the firm?
  9. How does Water Island Capital invest across market cycles and corporate events?
  10. How do interest rates impact returns in a merger arbitrage strategy?

An investor should consider the investment objectives, risks, charges and expenses of the Fund carefully before investing. The current prospectus contains this and other information about the Fund. To obtain a prospectus, please visit the Fund's "Fund Information" page on this website. Please read the prospectus carefully before investing.

RISKS: The Fund uses investment techniques with risks that are different from the risks ordinarily associated with equity investments. Such techniques and strategies include merger arbitrage risks, high portfolio turnover risks, options risks, borrowing risks, short sale risks, and foreign investment risks, which may increase volatility and may increase costs and lower performance.

The Arbitrage Funds are distributed by ALPS Distributors Inc., which is not affiliated with the advisor or any of its affiliates.

 

Who is the advisor to The Arbitrage Fund?

Water Island Capital, an SEC-registered investment advisor, has served as the advisor to The Arbitrage Fund since its inception in 2000. The firm seeks to add alpha through rigorous fundamental research and opportunistic trading in risk arbitrage and event-driven situations. Water Island specializes in merger arbitrage, equity special situations, and credit opportunities strategies that are offered through liquid alternative mutual funds, hedge funds, and customized separate accounts. Managing over $3 billion in event-driven strategies (as of 5/31/13), the nucleus of the firm’s investment team has worked together for over a decade. This independent, employee-owned firm is headquartered in New York, with an affiliated FCA-registered office in London.

Alpha, a measure of performance on a risk-adjusted basis, takes the volatility of a portfolio and compares its risk-adjusted performance to a benchmark index. The excess return of the portfolio relative to the return of the benchmark is the portfolio’s alpha. The FCA (Financial Conduct Authority) is a U.K. entity responsible for regulating financial firms providing services to consumers and maintaining the integrity of the U.K.’s financial markets.

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What is your long-term mission?

Water Island Capital’s mission is to provide best-in-class global event-driven investment capabilities to our fellow Arbitrage Fund shareholders, and our investment philosophy aims to protect capital in all market environments. This principle is at the heart of our definable, repeatable, consistent portfolio construction process and risk assessment philosophy. It is also our belief that investing in people, systems, and technology will lead to success over the long run. Delivering transparency and detailed attribution to our investors is another core objective for our team, and since the firm’s founding in 2000, we have worked diligently towards achieving all of the goals outlined above. We intend to sustain a top-tier investment advisory firm built for longevity through continued self-evaluation, assessment, and investment, while maintaining a unique culture driven by our desire to remain a client-focused money manager.

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What are some of the major events in Water Island Capital’s evolution over time?

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How have the Arbitrage Fund’s management team, process, or philosophy evolved over time?

Portfolio Managers John Orrico, CFA, Todd Munn, and Roger Foltynowicz, CAIA have been leading the Arbitrage Fund’s investment team together for more than a decade. Today, they are served by more investment resources than ever before. The team has maintained the same philosophy and decision-making process since the Fund’s inception.

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Has the Arbitrage Fund experienced “style drift” due to changes in strategic composition or geographic exposure?

No, our portfolio continues to reflect what we believe are the most attractive announced equity merger transactions across the entire global deal universe, and the Fund’s process and philosophy have remained the same since inception. As seen below, a maturing globalized economy has led to much of today’s M&A (mergers and acquisitions) activity – not just in our portfolio, but in the entire deal universe – involving at least one non-U.S. entity as a party to a transaction.

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Arbitrage Fund Quarterly Historical Region Exposure
Q1 2007 Q2 2007 Q3 2007 Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008
US 74.40% 81.10% 83.70% 75.90% 67.90% 80.10% 76.80% 89.30%
Canada 8.90% 12.00% 8.70% 13.30% 20.40% 16.30% 13.40% 3.30%
EMEA 15.40% 4.60% 7.10% 8.00% 7.90% 1.80% 5.10% 7.30%
APAC 1.30% 2.30% 0.40% 2.80% 3.80% 1.80% 4.80% 0.10%
Other (LatAm) 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Q1 2009 Q2 2009 Q3 2009 Q4 2009 Q1 2010 Q2 2010 Q3 2010 Q4 2010
US 75.80% 73.10% 93.00% 87.40% 88.50% 83.20% 78.00% 80.50%
Canada 10.60% 13.50% 1.50% 6.70% 2.80% 1.50% 2.20% 6.20%
EMEA 7.20% 5.60% 1.30% 3.00% 2.40% 3.80% 5.70% 4.30%
APAC 6.40% 7.80% 4.20% 2.90% 6.30% 11.50% 14.10% 9.00%
Other (LatAm) 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Q1 2011 Q2 2011 Q3 2011 Q4 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012 Q1 2013
US 71.80% 80.10% 66.60% 77.20% 63.40% 63.10% 50.50% 51.40% 67.50%
Canada 11.20% 3.40% 1.80% 6.20% 13.10% 15.40% 20.20% 22.70% 7.70%
EMEA 8.10% 11.80% 16.20% 6.20% 4.00% 10.70% 15.30% 8.90% 10.70%
APAC 8.80% 3.80% 13.30% 10.40% 19.10% 9.80% 12.70% 14.90% 14.00%
Other (LatAm) 0.00% 0.90% 2.20% 0.10% 0.40% 1.10% 1.30% 2.10% 0.00%

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LatAm: Latin America. Style drift is the divergence of a mutual fund from its stated investment style or objective. Style drift occurs as a result of a change in the fund's management or intentional portfolio investing decisions by management.

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How has international geographic exposure contributed to recent returns?

The Fund has a long track record of successfully investing in international and cross-border transactions. Deals with an international element have provided a net overall benefit to the Arbitrage Fund in five out of the last six years, and quite frequently, some of the best performing positions in the portfolio in any given year have involved at least one international party. That said, it is important to note: Should two U.S. companies merge, yet one has business operations outside of the U.S., the transaction would likely still require European Union, Chinese government, Japanese, or other jurisdictional approvals depending on the geographic presence. We therefore believe global research capabilities are necessary to invest effectively in merger arbitrage today and going forward – even in the case of “U.S. Domestic deals.”

The Arbitrage Fund has a long history of successfully investing in transactions across the globe.

2007 Top Ten Deal Winners 2008 Top Ten Deal Winners
Regional Boundary Acquirer → Target Regions Regional Boundary Acquirer → Target Regions
Domestic U.S. → U.S. Cross-Border U.S./ex-U.S. EMEA → U.S.
Cross-Border International EMEA → Canada Domestic U.S. → U.S.
Domestic U.S. → U.S. Cross-Border International EMEA → Canada
Domestic U.S. → U.S. Domestic U.S. → U.S.
Domestic U.S. → U.S. Cross-Border U.S./ex-U.S. EMEA → U.S.
International EMEA → EMEA Cross-Border U.S./ex-U.S. APAC → U.S.
Cross-Border North America U.S. → Canada Cross-Border U.S./ex-U.S. EMEA → U.S.
Domestic U.S. → U.S. Cross-Border U.S./ex-U.S. EMEA → U.S.
Domestic U.S. → U.S. Cross-Border U.S./ex-U.S. APAC → U.S.
Cross-Border International EMEA → EMEA Domestic U.S. → U.S.
2009 Top Ten Deal Winners 2010 Top Ten Deal Winners
Regional Boundary Acquirer → Target Regions Regional Boundary Acquirer → Target Regions
Canada Canada → Canada Domestic U.S. → U.S.
Cross-Border International APAC → APAC International EMEA → EMEA
Domestic U.S. → U.S. Cross-Border International APAC → APAC
Domestic U.S. → U.S. Cross-Border U.S./ex-U.S. U.S. → EMEA
International APAC → APAC Cross-Border U.S./ex-U.S. U.S. → EMEA
Domestic U.S. → U.S. Cross-Border U.S./ex-U.S. U.S. → APAC
Domestic U.S. → U.S. Canada Canada → Canada
Cross-Border North America Canada → U.S. Cross-Border North America U.S. → Canada
Domestic U.S. → U.S. Domestic U.S. → U.S.
Canada Canada → Canada Domestic U.S. → U.S.
2011 Top Ten Deal Winners 2012 Top Ten Deal Winners
Regional Boundary Acquirer → Target Regions Regional Boundary Acquirer → Target Regions
Domestic U.S. → U.S. Cross-Border International APAC → Canada
Cross-Border U.S./ex-U.S. EMEA → U.S. Domestic U.S. → U.S.
Domestic U.S. → U.S. Cross-Border U.S./ex-U.S. APAC → U.S.
Domestic U.S. → U.S. Domestic U.S. → U.S.
Domestic U.S. → U.S. Domestic U.S. → U.S.
Cross-Border International Multiple Regions → APAC Domestic U.S. → U.S.
Canada Canada → Canada Domestic U.S. → U.S.
Cross-Border U.S./ex-U.S. U.S. → APAC International APAC → APAC
Domestic U.S. → U.S. Domestic U.S. → U.S.
Cross-Border North America U.S. → Canada Domestic U.S. → U.S.

 

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How has the Arbitrage Fund evolved in terms of market capitalization exposure over time?

The portfolio continues to reflect what we believe are the most attractive announced merger transactions across the entire market cap spectrum. As seen in the data below, market capitalizations of M&A target companies both within the Fund and in the broader deal universe fluctuate over time based on a variety of factors including economic cycles.

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Arbitrage Fund Quarterly Market Cap Exposure
Q1 2007 Q2 2007 Q3 2007 Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008
Small Cap (Under $2B) 63.60% 54.60% 42.40% 59.00% 53.40% 51.30% 50.60% 43.10%
Mid Cap ($2B - $10B) 29.50% 37.60% 41.50% 33.10% 30.30% 32.20% 32.30% 20.70%
Large Cap ($10B) 6.90% 7.80% 16.10% 7.90% 16.30% 16.60% 17.10% 36.20%
Assets Under Management ($MM) $165 $172 $177 $172 $179 $189 $209 $195
Wtd Avg Mkt Cap ($MM) $2,700 $5,200 $5,100 $3,500 $5,100 $4,700 $9,300 $7,100
Median Mkt Cap ($MM) $1,011 $1,517 $1,568 $936 $1,129 $712 $818 $817
Q1 2009 Q2 2009 Q3 2009 Q4 2009 Q1 2010 Q2 2010 Q3 2010 Q4 2010
Small Cap (Under $2B) 49.10% 61.80% 42.30% 56.80% 54.70% 56.10% 46.50% 35.70%
Mid Cap ($2B - $10B) 13.30% 26.20% 44.20% 30.90% 26.90% 40.00% 44.70% 51.00%
Large Cap ($10B) 37.70% 12.00% 13.50% 12.20% 18.40% 3.90% 8.80% 13.40%
Assets Under Management ($MM) $274 $340 $445 $678 $1,196 $1,437 $1,986 $2,244
Wtd Avg Mkt Cap ($MM) $11,100 $6,000 $8,300 $5,600 $6,400 $3,800 $5,200 $6,300
Median Mkt Cap ($MM) $314 $907 $983 $581 $630 $882 $607 $814
Q1 2011 Q2 2011 Q3 2011 Q4 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012 Q1 2013
Small Cap (Under $2B) 35.10% 45.20% 37.10% 38.20% 31.70% 23.70% 31.70% 20.30% 23.40%
Mid Cap ($2B - $10B) 57.90% 50.80% 51.30% 47.30% 38.70% 47.10% 53.70% 59.10% 58.50%
Large Cap ($10B) 7.10% 4.00% 11.70% 14.40% 29.60% 29.30% 13.00% 18.50% 18.10%
Assets Under Management ($MM) $2,376 $2,224 $2,388 $2,628 $3,092 $3,174 $3,210 $2,977 $2,957
Wtd Avg Mkt Cap ($MM) $4,400 $3,600 $4,700 $4,700 $7,500 $8,100 $4,600 $6,100 $7,300
Median Mkt Cap ($MM) $938 $910 $1,081 $948 $1,103 $980 $1,176 $1,178 $1,563

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How have Arbitrage Fund shareholders benefited from the growth in assets under management at the firm?

  1. Water Island Capital has demonstrated its commitment to long-term excellence by adding in-house resources and expertise, while investing in and advocating for shareholder-friendly infrastructure.

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    Headcount
    2007 2013
    PMs 3 3
    Analysts 1 11
    Traders 0 2
    Operations 1 4
    Compliance 1 2

  2. The Arbitrage Fund’s expense ratio has outpaced industry trends by decreasing nearly 30% in the past six years.

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    2009 2010 2011 2012 2013
    Arbitrage Fund (Retail Shares - ARBFX) 1.88% 1.69% 1.69% 1.52% 1.44%
    Arbitrage Fund (Institutional Shares - ARBNX) 1.63% 1.44% 1.44% 1.27% 1.19%
    Morningstar Market Neutral Category Average 1.82% 1.77% 1.66% 1.66% 1.78%

  3. The Fund is served by an independent board, which is considered a “best practices” industry structure.

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How does Water Island Capital invest across market cycles and corporate events?

As a global event-driven manager, Water Island Capital seeks to profit by investing in a broad range of scenarios involving specific catalysts or corporate events. The return streams around such events have frequently been less correlated to the overall direction of the broader credit or equity markets, and more related to the idiosyncrasies of the particular catalyst.

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Different types of events may be more likely to occur at different points throughout the market cycle.

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Definitions: Debt-for-Equity Swaps: An agreement in which a debt-holder receives an equity position in exchange for cancellation of their existing debt. “Busted” Convertibles: A convertible security for which the market price of the common stock is so low that the convertible feature is nearly worthless, causing the security to trade similar to a fixed income investment. Liquidity Crisis: Period of short term or technical insolvency during which organizations cannot meet their financial demands or obligations. Mergers/Acquisitions: A merger is the combining of two or more entities into one through a pooling of interests. An acquisition is the process of acquiring control of a corporation, the target, by stock purchase or exchange. Hostile Bids: An initial offer aimed at taking over a target company against the wishes of the target’s management team and/or board of directors. Post-Reorganization Equity: Shares issued by a firm that has recently emerged from bankruptcy proceedings. Recapitalization: Restructuring a company’s debt and equity mixture, commonly with the aim of making a company’s capital structure more stable. Litigation: Ultimate legal method for settling controversies or disputes between and among persons, organizations, and the State. Distressed Debt: Debt of organizations or government entities that are either already in default, under bankruptcy protection, or in distress and heading toward such a condition. Spin-off/Subsidiary IPO: The creation of an independent company through the sale or distribution of new shares of an existing business of a parent company. Thematic Trade with Catalyst: A trading strategy that is not based on a particular instrument or market, but rather on secular changes in fundamental economic variables or relationships inspired by a specific event or series of events. Management Change: The change of top executives and personnel that control the decisions of a corporation. Sum-of-Parts Trade: A trading strategy based on realizing inefficiencies between a company’s present valuation and its estimated valuation determined by valuing what its divisions would be worth if they were broken up. Deleveraging: A company’s attempt to adjust its balance sheet by decreasing the amount of financial leverage, or debt. Covenant Violations: The violation of contractual obligations or promises made by a debtor to a creditor. Downsizing: A company’s attempt to cut costs by reducing its fixed and/or variable expenses. Dutch Tenders: A type of share repurchase, or tender offer, where a company specifies a price range within which shares will ultimately be purchased. Shareholders are afforded the right to tender their stock at any price within the stated range. The company then compiles shareholder responses, and the final purchase price is set at the lowest price allowing the company to buy the number of shares sought in the repurchase offer. The final purchase price is then paid to all investors who tendered at or below that price. Minority Buyouts: When a controlling shareholder purchases the remaining shares of a company from the minority, or non-controlling, shareholders.

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How do interest rates impact returns in a merger arbitrage strategy?

Short-term interest rates are one of a number of components that impact returns in a merger arbitrage strategy. For a more detailed discussion on the impact of rates, please visit the Research section of our website. See below for a comparison of how merger arbitrage strategy returns have fared in prior rising rate environments.

Performance Comparison in Rising Interest Rate Environments

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Standard Deviation, a measure of volatility, measures the degree of variation of returns around the average return. The Barclays Capital U.S. Aggregate Bond Index covers the U.S. investment grade fixed rate bond market. The HFRI Merger Arbitrage Index is an index of hedge funds that employ an investment process primarily focused on opportunities in equity and equity related instruments of companies which are currently engaged in a corporate transaction. One cannot invest directly in an index.

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Notes:
Dealogic data includes acquisitions, mergers, joint ventures, spin-offs, split-offs, privatizations, divestitures, tender offers, divestments, recapitalizations, and restructurings where the shares of the target are publicly traded. Only transactions with a value of at least U$50MM are included. The value of a transaction is defined as the cost to the acquirer where only the percentage acquired is eligible. Figures are based on equity value on the date of announcement. Transactions not denominated in U.S. dollars are converted to a U.S.-dollar equivalent on the date of announcement. The underlying data has been generated via Dealogic’s M&A Analytics.