what is event-driven investing? - the arbitrage fund · pdf filean investor should consider...

Event-Driven InvestingIdentifying Catalysts that Unlock Value

Important Information

Tender Offer: A public, open offer by a prospective acquirer to stockholders of a publicly traded corporation to

tender their stock for sale at a specified price over a specified time, subject to a minimum and maximum number

of shares.

An investor should consider the investment objectives, risks, charges and expenses of the Funds carefully before

investing. The current prospectus contains this and other information about the Funds. To obtain a prospectus, please

call (800) 295-4485 or visit our website at http://arbitragefunds.com. Please read the prospectus carefully before

investing. There is no guarantee the Funds will meet their stated objectives.

We are making this presentation available to you for your information and education. Any references in this presentation

to specific holdings are not to be considered recommendations by The Arbitrage Funds (the “Funds”) or Water Island

Capital (the “Advisor”), the Funds’ advisor. All portfolio holdings are subject to change at any time. Any discussion of

specific securities is intended to help readers understand the Advisor’s investment management style with respect to

the Funds’ portfolio holdings, and should not be regarded as a recommendation of any security or of the Funds. The Ar-

bitrage Fund seeks to achieve capital growth by engaging in merger arbitrage. The Arbitrage Credit Opportunities Fund

seeks to provide current income and capital growth. The Arbitrage Event-Driven Fund seeks to achieve capital growth.

Each of the Funds may change its investment objective without shareholder approval.

RISKS: The Funds use 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, non-diversification risks, and foreign investment risks, which may increase volatility

and may increase costs and lower performance. The Arbitrage Event-Driven Fund also invests in debt securities, which

may decrease in value as interest rates increase. Asset allocation and diversification do not assure a profit or protect

against loss in declining financial markets.

The Arbitrage Funds • 3

What is Event-Driven Investing?

A scan of global business news on any given day will show corporate activity that may be of little interest to most ca-

sual readers. But to investors who seek to capitalize on price fluctuations caused by significant corporate actions and

announcements, these events are opportunities awaiting scrutiny.

Recent headlines show catalysts abound.

• AstraZeneca Urged to Engage with Pfizer

• Darden Spins Off Red Lobster

• Deutsche Bank Plans to Raise Fresh Capital

• Activist Turns Up Pressure on Allergan

• Tyson Enters Bidding for Hillshire Brands

• Walgreens Shareholder Opposes Potential Deal to Reincorporate Abroad

Event-driven investing, which strives to analyze and profit from the opportunities associated with distinct events taking

place across the corporate landscape, has long been employed by pension funds and other institutional investors.

Event-driven investors use fundamental analysis and sophisticated hedging techniques in an attempt to capture the

event’s effect on security prices while isolating the return from market movements. This highly-specialized investment

approach has also been an important strategy for hedge funds. In fact, event-driven is the second most popular hedge

fund strategy with $780 billion allocated to the category, according to Hedge Fund Research Inc.* We believe today’s

low-growth economy, cheap financing and cash-rich corporations are creating an ideal environment for this strategy.

An event-driven portfolio may be composed of these three

sub-strategies: merger arbitrage, credit opportunities and

equity special situations. Each sub-strategy seeks to capital-

ize on the mispricing of stocks, bonds and other securities

caused by the announcement or anticipation of corporate

events such as:

• Mergers and Acquisitions • Spin-offs

• Restructurings • Shareholder Activism

• Refinancings • Regulatory Changes

• Recapitalizations • Tender Offers

Sub-Strategies of Event-Driven Investing

Sub-Strategies of Event Driven

Investing

MergerArbitrage

CreditOpportunities

EquitySpecial

Situations

*As of 12/31/14.

Because corporations are are always pursuing ways to unlock shareholder value, event-driven investing is an all-weather strategywith many types of situations to evaluate and capitalize on during different points in the business and economic cycles.

An All-Weather Strategy

4

Trough and Early Recovery Mid Cycle Peak and Decline

Debt-for-Equity Swaps“Busted” Convertibles

Liquidity CrisisMergers & Acquisitions

Hostile BidsPost-Reorganization Equity

RecapitalizationLitigation

Distressed Debt

Covenant ViolationsRecapitalizationsLiquidity Crisis

Mergers & AcquisitionsDownsizing

Dutch TendersMinority BuyoutsDistressed Debt

Thematic Trade with CatalystManagement Change

Mergers & AcquisitionsSum-of-Parts Trade

Deleveraging

Spin-Off / Subsidiary IPO

Economic Cycle

Start-Up/Recovery Growth Maturity Decline

Corporate RefinancingCorporate Restructurings

Hostile TakeoversMergers and Acquisitions

Pre-ArbitrageSyndicates

Topping BidsManagement Change

Mergers and AcquisitionsPre-Arbitrage

Syndicates

Topping BidsManagement Change

Post-Bankruptcy Reorganization

Broken DealsCorporate Refinancing

Corporate RestructuringsDeleveraging

SyndicatesLitigation

Management ChangeShareholder Activism

BankruptcyDownsizing

Spin-Offs & Split-Offs

Spin-Offs & Split-OffsTender Offers

Tender Offers

Tender Offers

Broken DealsCorporate Refinancing

Corporate RestructuringsDeleveraging

Hostile TakeoversMergers and Acquisitions

Downsizing

Business Cycle

Event-Driven Investing • 5

How Event-Driven Investment Strategies Fit in a Well Balanced Portfolio

The benefits of diversification are well known: Spread capital across an array of assets whose performance is not en-tirely tied to one another to help mitigate market volatility and potentially smooth portfolio returns. Traditionally, thishas been achieved through, for example, a portfolio allocated 60% to stocks and 40% to bonds -- where equities addmost of the risk and return, while bonds provide a ballast during market sell-offs.

As the graph below illustrates, event-driven investment strategies have historically shown the potential to improve aninvestor's risk/return experience. Indeed, due to the specificity of corporate events and actions, event-driven investmentstrategies have demonstrated the ability to deliver returns with low correlations to the performance of equity and fixedincome markets. We believe adding a portfolio comprising event-driven investments would have lowered risk and in-creased returns in a traditional balanced portfolio.

Annualized Standard Deviation

Annu

aliz

ed R

etur

n

12%

11%

10%

9%

8%

6% 7% 8% 9% 10%

HFRI Event-Driven Index

Traditional Balanced Portfolio

40% HFRI Event-Driven -60% Traditional Balanced Portfolio




Date range: Jan. 1, 1990-Dec. 31, 2014 Traditional Balanced Portfolio is comprised of 60% stocks (represented by the S&P 500 Index) and 40%bonds (represented by the Barclays U.S. Aggregate Index), rebalanced annually. Past performance is not a guarantee of future results. Index returnsare for illustrative purposes only and do not represent actual fund performance. Index performance returns do not reflect any management fees,transaction costs, or expenses. Indexes are unmanaged and one cannot invest directly in an index. The Standard and Poor's 500 Index is a capitaliza-tion-weighted index of 500 stocks designed to measure performance of the broad domestic economy. The Barclays Capital U.S. Aggregate Bond Indexcovers the U.S. investment grade fixed rate bond market. The HFRI Event-Driven Index includes funds who maintain positions in companies currentlyor prospectively involved in corporate transactions of a wide variety including but not limited to mergers, restructurings, financial distress, tender offers,shareholder buybacks, debt exchanges, security issuance or other capital structure adjustments.

Source: Zephyr StyleAdvisor

Event-Driven Strategies Have Historically Improved the Risk/Return Experience

Spotlight on Merger Arbitrage: All Stock Deal

6

Past performance is not a guarantee of future results.

$

Time

Deal Value (2x Company A): $5.96

Spread:$0.43

Company B: $5.53

Company A: $2.98

Day 1:Merger announced. Company A agrees to buy Company B for apurchase price of 2 shares Co. A in exchange for every 1 share Co. B.Trade: Buy 1 share Company B, sell short 2 shares Company A.

Company A: Acquirer

Company B: Target

Deal Value: 2x Company A

Spread (Profit Potential)

Return on Trade

Annualized Return

Day 180:Transaction closes successfully. Company B shares become Company Ashares, and our long and short positions in Co. A collapse. Even if the value ofCo. A has declined, we have locked in our return by selling short on Day 1. 1 Year

Spread = Deal Value – Target Price$5.96 – $5.53 = $0.43Percent Return = Spread ÷ Target Price$0.43 ÷ $5.53 = 7.8%

Time to Close = Days in Year ÷ Deal Timeline365 ÷ 180 Days = 2Annualized Return = Percent Return · Time to Close7.8% · 2 = 15.6%

CATALYST Company A reaches an agreement to acquire Company B for a purchase price of two shares of A in exchange for one shareof B. The deal is expected to close 180 days.

INVESTMENT THESIS After examining the terms of the acquisition, it is determined that the deal makes strategic sense, which increases thelikelihood of its completion. It is also determined that arbitrageurs are being compensated for the risk that the deal is ter-minated, which is reflected in the ‘spread,’ or the difference between the value of the acquisition offer and where thetarget company’s shares are trading.

POSITIONING To capture the spread, arbitrageurs purchase one share of company B worth $5.53 and sell short two shares of companyA worth $5.96. Company A’s shares are sold short to protect the defined spread against the possibility of them decliningin value. The $0.43 difference between the offer price and the market’s assessment of that offer translates into nearly8% rate of return.

POTENTIAL OUTCOMEAfter 180 days, the transaction successfully closes and the spread collapses to the offer price. Arbitrageurs receive twoshares of Company A worth $5.96 for each Company B share they own and promptly closing the position.

This hypothetical example is meant to illustrate the mechanics of a merger arbitrage investment.

This is a hypothetical example for illustrative and educational purposes only. This does not represent actual holding performance. This is nota recommendation to purchase or sell. Historical performance is not a guarantee of future results. Other event driven strategies may resultin the loss of principal and may not be successful. And these strategies could take more or less time and have different outcomes.


Spotlight on Credit Special Situations: Corporate Restructuring

CATALYST

In July 2014, Company B announced that it wanted to restructure its balance sheet to reduce its debt by nearly 50%.

INVESTMENT THESIS

The Company’s unsecured notes were to be exchanged for a combination of $225 million in cash, $775 million in seniorsecured notes, $100 million in convertible senior subordinated notes, and 82.5% of the new common equity. In this ex-ample, even in the worst case, the potential rate of return could be in the mid-teens. After analyzing the recapitalizationplan, the then-current capital structure, and performing downside analysis, the existing unsecured notes would be attractiveat prices in the mid-50s.

POSITIONING

Purchased Company B’s 7.3% unsecured notes due 2015 at 56% of par value.

POTENTIAL OUTCOME

After the completion of the restructuring, the sum-of-the-parts value of the trade was 74% of par based on the prices forthe exchanged securities, representing a 32% gross return.

This hypothetical example is meant to illustrate the mechanics of an event-driven credit investment.

Pre-Trade Sum-of-the-Parts Analysis Trade & Outcome

Past performance is not a guarantee of future results. Source: Bloomberg

BearCase

BaseCase

BullCase

Original bond:Company B 7.3%Senior Notes

due 2015

Exchanged securities:Cash Distribution

9.25% Senior Secured Notes due 20188%/12% Convertible Notes due 2022

Common Equity

Profit Potential

32% ProfitRealized

Common Equity (traded at $6.86 after restructuring)Convertible Notes (traded at 79% of par after restructuring)

Senior Secured Notes (traded at 99.5% of par after restructuring)

Accrued Interest

Cash Distribution

8/8/14:Original Bond

Purchasedat 56% of par

12/20/14:Restructuring Complete,

Original BondExchanged


Spotlight on Equity Special Situations: Spin-Offs

8

CATALYST In May, B Inc. abruptly canceled its investor meeting and announced a review of strategic alternatives. It also announcedan activist investor had accumulated a 4% stake in the company.

INVESTMENT THESIS Rumors of a spin-off and the interest of activist investors had propelled the shares 30% higher to $97 on the day before theofficial announcement from $75 in mid-April. When the company unveiled its plans to split its two units--one manufactures in-teriors for commercial airlines; the other distributes airplane parts around the world for maintenance and upkeep--the sharessold off. The manufacturing business is estimated to be worth $60-to-$70 a share. Given the industry has been consolidatingas customers look to save costs by sourcing from a single supplier, B could fetch as much as $85 a share from a strategic ac-quirer. The logistics and parts business, which is an industry leader with the potential to consolidate the industry, is estimatedto be worth $30 a share. Based on a sum-of-the-parts analysis, B’s post-event fair value is calculated at $90-to-$115 a share.

POSITIONING B’s shares sold off as investors lost patience with the spin-off, falling to the high $70s, which provided an entry point withcompelling upside. Shares of B were accumulated throughout the fall and the position was hedged with a basket of peersto isolate the trade from the broader market’s performance.

POTENTIAL OUTCOMEB Inc. conducted the spin-off via a dividend distribution whereby each shareholder received one SpinCo (logistics andparts unit) share for every two shares of B. The spin-off was completed mid-December, and the value of the sum of theshares (1 B Inc. + 0.5 of Spinco), now trading independently, reached $85 on the first day of trading and has hit as highas $92 since then.

Pursuit of strategicalternatives announced

Spin-offcompleted

20

30

40

50

60

70

80

90

100

110

$120

Feb 2014

Mar 2014

Apr2014

May2014

Jun2014

Jul 2014

Aug 2014

Sept 2014

Oct2014

Nov 2014

Dec 2014

Jan 2015

Feb2015

Spin-offannounced

B Inc. SpinCo Target Sum of Parts Actual Sum of Parts

This hypothetical example is meant to illustrate the mechanics of an event-driven equity investment.

Past performance is not a guarantee of future results.



Why Choose Event-Driven Investment Strategies Now

A slow-growth global economy, relatively cheap financing terms and cash-rich balance sheets are spurring companiesto unlock shareholder value, whether it be through spin-offs, restructuring, refinancings or acquisitions, to name afew. For event-driven investors, this is an environment ripe with potential investment opportunities.

While event-driven investment strategies seek to generate risk-adjusted returns regardless of the performance ofbroader markets, each of the sub-strategies has attributes of bonds and stocks. When properly executed, merger arbi-trage, equity special situations and credit opportunities have historically mitigated portfolio risk and provided growth.An allocation to a dynamic blend of all three event-driven strategies has historically provided portfolios with more con-sistent, long-term results.

The Arbitrage Funds family was founded in 2000 to deliver alternative investment strategies to a broad audience ofinvestors.

Through the Arbitrage Funds, investors have the opportunity to diversify their portfolios by investing in an approach that

has historically demonstrated a low correlation to broader market performance and economic activity. At the ArbitrageFunds family, we believe that principal protection is paramount for generating attractive long term returns.

Each of the Arbitrage Funds focuses on different parts of the event-driven landscape–the Arbitrage Fund on stocks

of companies involved in mergers and acquisitions; the Arbitrage Credit Opportunities Fund on bonds and other

credit instruments; and the Arbitrage Event-Driven Fund, which combines merger arbitrage, credit opportunities and

equity special situation sub-strategies in a dynamically-allocated portfolio.

To learn more about how the Arbitrage Funds family fits in a well-diversified portfolio, please contact us for more

information.

ArbitrageFunds.com

41 Madison Avenue

42nd Floor

New York, NY 10010

1-800-295-4485

Distributed by ALPS Distributors Inc., which is not affiliated with the Advisor or any other affiliate. [ARB00678 2016-03-31]

what is event-driven investing? - the arbitrage fund · pdf filean investor should consider...

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