Merger-Arb 101


What is Merger-Arbitrage?

Merger-Arb is an alternative to traditional fixed income designed to produce higher returns with lower risk than a traditional bond fund. Here at Constantia Capital, Merger-Arb is our most successful focused investment strategy.

In this video, Harvey Fram, CFA, Founder of Constantia Capital, uses the Green Mountain Coffee takeover example to explain how we use Merger-Arb in the portfolios we manage. 

Takeover Example

No two public corporate acquisitions are identical, but similarities in their stock movement pattern between announcement day and deal consummation do exist. A typical/actual case in point example is illustrated here and in the above video. 

Cash Takeover Stock Behavior-Constantia.


The high number of deals which meet our risk-control criteria and enter the portfolio doesn't necessarily increase returns but it does mitigate risk and lower the volatility of returns.  Currently we are invested in over 100 deals making for an extremely diversified portfolio.


Frequently Asked Questions

Merger-Arbitrage sounds very complicated, like it involves financial engineering, inside information, or other risky techniques – right?

Nothing could be further from the truth. It’s very straightforward actually. It invests only in definitively announced acquisitions AFTER they’ve been announced and become public information. Even after public announcement, a sufficient ‘spread’ to deal consummation remains, which in a diversified portfolio of similar deals, when diligently monitored and professionally managed, produces superior risk-adjusted returns.


Does Merger-Arbitrage invest in stocks or bonds?

Merger-Arbitrage invests only in stocks (equities), not in bonds nor any kind of equity derivatives, such as options. It invests only in the publicly traded stocks of those companies who have confirmed, definitive agreements to be acquired. Post-announcement, the merger ‘targets’ have a known future price -the takeover deal price- hence have minimal stock market volatility. Therefore, Merger-Arbitrage is considered more like fixed-income (bond) investing, and is a good diversification choice for the fixed-income allocation of a well-balanced portfolio.


Why shouldn’t I just stay in my Treasury bond funds which have produced strong returns for many years already and have very low fees?

Treasury bond funds should be a core holding for all balanced portfolios, especially (but not only) high net worth individuals/families.  Most of their recent impressive returns have been due to interest rates falling for a protracted period, down to their current extremely low levels. If interest rates rise, a bond’s market value falls, Treasuries included. They will continue to pay their coupon interest rates, but the market value of the bonds themselves and the bond fund holding them will decrease – this is an arithmetic certainty.


But don’t the low fees offered by Vanguard and Fidelity bond funds make them a better choice?

Those are excellent choices for the cash/fixed-income allocation of any portfolio, but Merger-Arbitrage’s after-tax, net (after fees, what the investor receives) returns, even for those in a high tax bracket, have exceeded those funds even with recent unprecedented low interest-rates.  If interest rates do rise, the decrease in bond prices will completely negate their low-fee advantage and far worse.


How will Merger-Arbitrage do in a rising interest rate environment?

Merger-Arbitrage earns its returns by the ‘spread’ between a target’s market-traded price and the ultimate takeout price. The market imputes that spread by a combination of (i) short term interest rates and (ii) the deal’s perceived riskiness (of being consummated). The average “duration” of merger deals is between 4 and 5 months.  If interest rates rise, Merger-Arbitrage existing deal spreads tend to widen which will detract from the value of its current holdings, of similar magnitude to the negative impact on a 6-month Treasury bill, but much less than the shock to a higher duration 10-year or longer bond. Deals newly announced in a higher interest rate environment will enter the portfolio with a higher average spread consisting of the higher short-term interest rate and an analogous risk premium (intrinsic to the probability of deal consummation).


Wouldn’t I do better by just investing passively in the broad market with an ultra-low fee ETF like SPY or QQQ?

A balanced portfolio should have some allocation to the broad equity market, whether/Including actively or passively managed. You or your financial advisor decide that – we do not. If you’re “all in” the stock market, expect a wild ride and be prepared to stomach the volatility. You should also have some allocation to less risky investments, such as fixed income/bonds. Within the broad array of fixed-income choices, you should further diversify by allocating a portion in Merger-Arbitrage since it has delivered better performance with less volatility than the great majority of Treasury bond funds.


How do I know if Merger-Arbitrage is performing well, if you don’t compare it to the stock market?

Fixed-income investment choices are broad and varied but none of them are measured against the stock market, since they are entirely distinct asset classes with different objectives. Fixed income strategies try to achieve returns with less risk than the stock market and measure themselves against the alternative of holding cash – which has no volatility and almost no return. Therefore, Merger-Arbitrage’s “benchmark” is cash, as measured by 3 mo. USD LIBOR.

Bottom line: Merger-Arbitrage earns significantly more than cash for slightly more risk.  Hence the prior name “High Yield Cash”.


Does Merger-Arbitrage invest in only US companies?

The great majority are US publicly traded equities, but when foreign publicly listed companies are involved, we always hedge the foreign currency risk.


Taxes - are Merger-Arbitrage’s returns exempt from federal, state, or local taxes? 

No, but approximately 1/5 of the returns are qualified dividends which are taxed at the same rate as long-term capital gains. Most of Merger-Arbitrage’s returns are short-term capital gains, which is taxed at the same Federal rate as interest income, just like the interest income from Treasury bond funds. 

Note that Merger-Arbitrage’s conservatively projected 4% net annualized return above the risk-free cash rate will still produce higher after-tax returns than bond funds in stable or rising interest rate scenarios. In fact, as of November 30, 2022, Merger-Arbitrage has returned 5.04% net annualized since inception in 2011.

Merger-Arbitrage account holders receive a Form 1099 (and trading history in electronic format) in order to prepare their Schedule D and accompanying Form 8949.


What if I want OUT!  How quickly can I liquidate, convert to cash?  Are there any lock-up periods?

As a separately managed account owner, you can revoke our investing authority instantly, then do whatever you want with the account. The great majority of the holdings are US equities which settle in T+2; the foreign equities’ trade settlement varies by country but the maximum is also T+2. So from the day you decide “OUT!” 90+% will be cash in 2 business days, perhaps 100%. However, while most positions are in very liquid equities, some are less liquid i.e. have a wider bid/asked spread and we'd recommend waiting several days for a best execution. That is your choice.


Is there any sales charge?

Absolutely not! Merger-Arbitrage is not a mutual fund, and there is no cost whatsoever to invest, except the time it takes to open your account.


How can I confirm your advertised returns?

Since Constantia Capital’s Merger-Arbitrage strategy is NOT a mutual fund, our returns are not published, but they are independently verified to be in conformance with the Global Investment Performance Standards ("GIPS") as promulgated by the CFA Institute. We're pleased to provide our independent verification of GIPS conformance, upon request.  Additionally, we can provide documentary proof of all returns via actual account statements, with client names redacted of course.


What about trading commissions?

All net returns are after all trading commissions and our fees (the same as any mutual fund); they’re what you the investor keep, and you can see your account’s balances real-time, any time (including intra-day) you want by logging into your Separately Managed Account. We do pay commissions when we trade on the assumption that our all-in price is better than if our orders were subject to "payment to order flow". Client accounts are traded together and commission split proportionally which further reduces transaction costs.

Is this one of those high frequency trading strategies I read about, or one that tries to short-term “time the market”?

Absolutely not! This is not an actively traded strategy, and we’re not day trading nor anything like that. Most stocks, once the deal is announced, if they meet our risk-control criteria and we invest in them, are rarely traded, but rather held to completion, which is on average 4-5 months. There are cases when developments particular to a deal require us to trade them prior to deal consummation (during the holding period), such as when the risk profile widens and we decrease holdings or entirely exit a deal.


How safe is my investment?

All accounts are insured by the S.I.P.C. up to $500,000 in equity value, maximum $250,000 in cash, per account. There are inherent risks to any stock or fixed-income investing which are mentioned in the Investing/Important Notes page of this website and described more fully in Constantia Capital’s Form ADV II brochure which is available at

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