How hedge funds profit from the uncertainty of corporate mergers and acquisitions

Merger arbitrage is a strategy designed to capture gains from stock price movements following a deal announcement. This video breaks down the mechanics of cash and share-for-share mergers, while highlighting the significant risks when deals collapse.

Merger arbitrage functions as an absolute return strategy, betting on the predictable price adjustments that follow a merger announcement. However, the strategy is inherently exposed to deal break risk, where regulatory hurdles or changing market conditions cause an acquisition to fail. The 2020 market selloff in the first quarter serves as a prime example of a difficult period for this approach.

The strategy must account for complex regulatory environments. A notable case is the 2000 merger attempt between General Electric and Honeywell. While the deal cleared the US Federal Trade Commission, it was ultimately blocked by the European Commission. This marked a historical shift as the first instance where non-US officials stopped a merger between two American companies that had already received approval from the Department of Justice.

Source: Merger Arbitrage Hedge Fund Strategy ― How Does it Work?