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CHAPTER 7 Profiting from the Corporate Life Cycle. This chapter will help investors understand the two most common event-driven hedge fund strategies, risk arbitrage, and distressed securities investing. The event-driven category is defined as strategies that seek to profit principally from the occurrence of some of the typical events that occur in a corporate life cycle | 7 Profiting from the Corporate Life Cycle This chapter will help investors understand the two most common event-driven hedge fund strategies risk arbitrage and distressed securities investing. The event-driven category is defined as strategies that seek to profit principally from the occurrence of some of the typical events that occur in a corporate life cycle such as mergers acquisitions spin-offs restructurings and recapitalizations. See Figure 7.1. In addition to risk arbitrage and distressed securities funds the event-driven strategy includes funds that are best classified as focusing on special situations although both risk arbitrageurs and distressed securities funds frequently get involved in activities that do not fall conveniently within the mainstream definition of either strategy. BETTING ON A TAKEOVER THROUGH MERGER RISK ARBITRAGE Investors in merger arbitrage also called risk arbitrage invest through hedge fund managers who take a long position in the target company of an announced takeover bid. In combination where the consideration is the stock of the acquirer the arbitrageur generally will sell that stock short. This strategy is analogous to the insurance business in that the arbitrageur is insuring existing shareholders against the risk of the deal not taking place. The spread between the market price and the offer 93 94 HEDGES ON HEDGE FUNDS Scope of hedge fund arbitrage and distressed opportunities FIGURE 7.1 Corporate Life Cycle. price is the equivalent of the insurance premium which will be the return to the arbitrageur should the deal proceed to completion. The risk arbitrage strategy should be considered as part of an overall allocation to alternative investments because it provides benefits such as low market correlation and a low standard deviation to an efficient diversified portfolio. In addition risk arbitrage funds have returned consistently strong profits to their investors for an extended period of time independent of overall market .
