Lately, Munn says he is seeing 4% to 6% annualized returns for safer transactions, compared with 3% to 4% in previous years. As the U.S. strengthens and the global economy stabilizes, boardroom confidence around the world usually grows, which should result in more transactions across a wider swath of industries, geographies and market capitalizations.

The path to profits for the fund depends on how the acquirer plans to finance a takeover. In a transaction where a company plans to acquire shares with cash, the fund may simply buy shares of the target company and wait for them to go up to the takeover price when the deal is completed. If an acquirer is using its stock to bring about the takeover, there’s a risk that the stock will fluctuate in the months it takes to complete the deal. To defuse that risk, the fund will typically purchase the target’s stock, while simultaneously selling short the shares of the acquirer. This hedging strategy helps ensure that even if the acquirer’s stock declines, the fund has locked in its return by selling short. In cases where acquirers use both cash and stock as currency, the managers will combine the two strategies.

Returns are calculated on an annualized basis. If a merger arbitrage transaction that takes four months to complete produces a return of 1.5%, for example, its annualized return is 4.5%. Because deals usually close in a few months, almost all gains are short term.

A big disparity between the post-announcement and acquisition offer signals that investors believe the deal is risky, perhaps because it could be canceled or delayed by regulatory snags or objections from shareholders. Transactions involving these deals have higher risks—and the potential for higher reward. A narrow spread indicates confidence in a swift and successful conclusion. Market conditions also play a role. An environment of low risk and low volatility generally translates into narrow spreads, while greater volatility widens them.

The fund’s managers focus on how likely, and how quickly, a publicly announced deal will get done. To find these deals, they screen a universe of 150 to 250 U.S. and foreign merger transactions around the world. After an analysis, they decide whether they will jump in or sit it out because of potential gotchas, such as antitrust issues or activist shareholders opposing a merger. The selection process winnows the universe down to the 40 to 80 mergers in progress in the portfolio at any given time.

Strategic, friendly transactions with low leverage and a high probability of completion offer the most appeal, and an optimal situation involves a high-caliber buyer, such as Warren Buffett or Oracle, with a history of long-term commitment to acquisitions and a track record of seeing deals to completion. “We like deals with a clear path to success,” says Munn. “We want to invest in those with the best risk-adjusted returns and the highest probability of closing.” About 98% of the deals in the fund eventually close, he adds.

Examples of deals in the fund working their way toward completion include insurer Ace Group’s bid for Chubb, another insurer. Foltynowicz believes Chubb’s higher-end, higher-premium business complements Ace’s expansive line of insurance products. “The combination of the two insurers will create one of the largest insurance companies in the world,” he notes. “And if Ace walks away for some reason, there will probably be a long line of other acquirers looking to take its place.” The stock and cash transaction, scheduled to close in January, is expected to return 6.5% on an annualized basis.

Another deal, Berkshire Hathaway’s bid for industrial goods and metal fabrication company Precision Castparts, was announced in August. Foltynowicz says Berkshire Hathaway is well-positioned to finance the $35 billion, all-cash acquisition, and he expects a 6.5% annualized return on the transaction. Another acquirer in the portfolio, Schlumberger, made an offer for Cameron International in late August. The latter company, which makes valves and equipment for the oil and gas processing industry, established a joint venture with Schlumberger in 2013 called OneSubsea. “These companies have worked successfully together, so they know what to expect from each other,” says Munn. “The long-term top-line growth potential is huge.” The cash and stock deal is expected to close in March 2016. 

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