Understanding Liquid Alternatives

Arbitrage Strategies

What Are Arbitrage Strategies?

Arbitrage strategies aim to capture pricing inefficiencies between related securities. These inefficiencies may be temporary and low-risk, but with consistent application and leverage, arbitrage strategies have the potential to offer attractive risk-adjusted returns.

In a liquid alternative format, arbitrage strategies are implemented with high levels of transparency and liquidity, making them accessible to a broader range of investors.

 

Key Types of Arbitrage

 

Merger Arbitrage

Also known as risk arbitrage, this strategy involves purchasing the stock of a company being acquired and shorting the stock of the acquiring company. Returns are driven by the spread between the current trading price and the acquisition price.

Drivers of Return:

  • Deal spreads
  • Time to completion

 

Convertible Arbitrage

This involves taking long positions in convertible securities (e.g., bonds or preferreds) and short positions in the underlying equity. The strategy attempts to profit from mispricing between the convertible bond's embedded equity option and the stock's market price.

Drivers of Return:

  • Volatility of the underlying stock
  • Interest rate differentials
  • Credit spreads

 

Event-Driven Arbitrage

These strategies focus on corporate actions such as spin-offs, restructurings, recapitalizations, or earnings surprises. The goal is to anticipate market reactions to such events and capture mispricing.

Drivers of Return:

  • Corporate catalysts
  • Market inefficiencies
  • Speed of price correction

 

Potential Benefits of Arbitrage in a Portfolio

  • Low Correlation: Returns often uncorrelated to broader equity and bond markets.
  • Consistent Return Stream: Profits driven by idiosyncratic events, not macro trends.
  • Risk Management: Generally, market-neutral with defined entry and exit points.

 

Risks to Consider

  • Deal failure or regulatory intervention (for merger arbitrage).
  • Liquidity mismatch in volatile markets.
  • Model or execution risk in complex trades.

 

Who Typically Uses Arbitrage Strategies?

  • Investors seeking capital preservation with returns uncorrelated to the overall equity market.
  • Allocations seeking the ability to invest across the corporate lifecycle.
  • Portfolios looking for additional low-risk diversifiers.

 

Related Fund

 

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There can be no assurance that an investment strategy will be successful. Historic market trends are not reliable indicators of actual future market behavior or future performance of any particular investment which may differ materially and should not be relied upon as such.

View definitions of benchmarks and other terms used here.

The investment strategy and themes discussed herein may not be in the best interest of investors depending on their specific investment objectives and financial situation.

Diversification does not eliminate the risk of experiencing investment losses. There is a risk of substantial loss associated with trading commodities, futures, options, derivatives and other financial instruments. Before trading, investors should carefully consider their financial position and risk tolerance to determine if the proposed trading style is appropriate. Investors should realize that when trading futures, commodities, options, derivatives and other financial instruments one could lose the full balance of their account. It is also possible to lose more than the initial deposit when trading derivatives or using leverage. All funds committed to such a trading strategy should be purely risk capital.

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