The Bocconi Students Investment Club’s paper delves into merger arbitrage, a strategy aimed at profiting from the price discrepancies during mergers and acquisitions. By examining 4,828 transactions from 1984 to 2020, the authors assess the viability of merger arbitrage as a means to generate consistent returns and enhance portfolio diversification.

The study employs advanced machine learning techniques, including logistic regression, tree-based models, and neural networks, to evaluate the factors influencing deal success. Variables such as board support, termination fees, and the transaction type (cash vs. stock) are analyzed to understand their impact on the strategy’s effectiveness.

The paper presents key figures that highlight the performance and risk attributes of merger arbitrage strategies over time.

Sources: BSIC, Morningstar

The comparison illustrates that while the S&P 500 achieved higher overall returns, especially after 2012, the Merger Fund exhibited lower volatility and more consistent performance. During market downturns, the Merger Fund experienced smaller drawdowns, suggesting its potential as a tool for downside protection.

Sources: BSIC, Morningstar

This figure highlights the Merger Fund’s performance during four bear market periods. In each case, the fund outperformed the S&P 500, often yielding positive returns or experiencing significantly smaller losses. This resilience underscores merger arbitrage’s ability to mitigate portfolio risk during adverse market conditions.

The insights from this research are valuable for investors seeking to enhance portfolio diversification through uncorrelated return streams. Merger arbitrage exhibits several characteristics that make it a compelling addition to a diversified portfolio:

• Low Correlation with Traditional Assets: The strategy’s returns are not directly tied to stock or bond market movements, offering potential benefits in smoothing overall portfolio returns.
• Downside Protection: Historical performance during market downturns demonstrates merger arbitrage’s capacity to reduce losses, aligning with the goals of strategies like return stacking.
• Consistent Returns: While not necessarily delivering high returns during bull markets, merger arbitrage has provided steady performance over time, contributing to a more predictable return profile.
• Deal-Specific Alpha: The potential for generating returns through careful analysis of individual deals resonates with concepts like portable alpha, where returns are derived from skill-based strategies independent of market beta.

Incorporating merger arbitrage into a portfolio aligns with the principles of diversification and may enhance risk-adjusted returns. For those interested in exploring this strategy further, more insights can be found in discussions about merger arbitrage.

“Exploring the Practicality of Merger Arbitrage” provides a comprehensive analysis of merger arbitrage as a strategy that can enhance portfolio diversification and resilience. By leveraging the unique characteristics of merger transactions, investors may achieve uncorrelated returns, mitigate downside risk, and benefit from consistent performance. While merger arbitrage is not without its risks, the paper’s findings suggest that, when implemented thoughtfully, it can be a valuable component in a diversified investment strategy.