In the previous post, I detailed the arbitrage process. In this post, let me provide some other resources to understand the process better.
Joe Ponzio (Fwallstreet) is a value investor and writes extremely well on value investing with a lot of clarity. He has written several posts on arbitrage with examples of specific companies such as the tribune company. In this post, and this post he talks of the 7 broad steps in a merger or accquisition. These steps are mainly around the due diligence of the deal, signing a definitive agreement, getting shareholder approval and follwed by the regulatory approvals. Once all the approvals have been taken, the probability of the transaction happening is high
As Joe’s indicates,correctly in this post – ‘In arbitrage, the goal is to earn high rates of return on an annualized basis in low-risk, high-certainty situations’. So by investing in a transaction which is past the major approvals, an investor can be confident that the transaction will happen , which reduces the risk component of an arbitrage transaction.
I would recommend you to read his arbitrage related post to get a good understanding on the process.
What are the kind transactions which can be considered for arbitrage ? I have written on these transactions in the past and am listing them here again
Spin-offs
Mergers : These can be friendly in nature or hostile. Friendly mergers have lower risk and lower return. Hostile mergers have higher risk and correspondingly higher returns. Mergers can involve cash merger where the target shareholder is paid cash for their holding or stock for stock exchange or a combination of the two.
Bankruptcy or restructuring
Recapitalizations
Arbitrage helps in generating positive returns during a bear market. However the downside is that this investment category requires a lot of work for the small returns you get in return. As a result arbitrage may not be suitable for someone who is able to devote only a few hours a month on investing.
2 comments:
Hi Rohit.
Good read..But these are the summary of books you read..what about your experience on the same..I read somewhere that average Risk Arbitrage Spread is 3% on monthly basis...(Annualized 36 %)..(This study is conducted for 40 year period)
I think this is very thin spread..For this we need to spend lot of time by Scanning (Reading BSE announcements) , Analysing , Hedging..
Too much for a part time investor like me..
But how I look at Risk Arbitrage is subset of Value Investing..I.e Some of deep value stocks you rejected (or you dont want to own for long time)because it could be a potential value trap (where you expecting that value wont get unlcoked for some reason)..But now we can invest because deal is announced we can expect the value get unlocked
For an example: I was tracking Allsec Technologies for long time as market cap went below 59 Cr ( NCA:41 Cr , Cash in Liquid Funds: 79 Cr), But I am NOT invested in this company because of low level ownership from management + Aggresive Acquiring urge of the management..
Whats interesting here is the famous VC Ashish Dhawan holds 4.92% of this company and CCRT International Holdings B V also holds 4.92 % of this company..And this can be acted as toehold to acquire this company..
If there is announcement to acquire this company..I will invest Because
1)I can get the Risk arbitrage spread after selling the stock to the acquirer
OR
2) I can still hold the stock even if the deal is not going to happen as it is very cheap stock and several other companies may be interested in the target..(who knows even I can become an acquirer :) )
plus some of my thoughts on shorting during the risk arbitrage are same as of Benhjamin Graham as explained by Gannon on Investing...(which is given below)
Regards
Vishnu
Graham’s partnership was a prototypical hedge fund. For starters, Graham actually hedged. He was short some securities and long others. For a while, he tried a basic long/short value approach, where he went long clearly cheap stocks and when short clearly expensive stocks. However, he found riding out the speculative surges in the stocks he was short to be an extremely unpleasant experience. He also found, over time, that he wasn’t especially good at finding stocks to short – certainly not good enough to get a better overall result (an investor has to be a lot more skilled at going short than going long to make it worth his while to short– if volatility and consistency aren’t as important to him as long-term results). Also, since Graham was always invested in an unusual mix of cheap stocks, liquidations, and related hedges, he was able to deliver rather consistent results without resorting to a more conventional long/short strategy. Eventually, Graham took the technique of shorting overpriced stocks out of his repertoire.
from http://www.gurufocus.com/news.php?id=33164
Hi vishnu
great comment
i have not done too much arbitrage. I am more in the learning exploratory phase and have 3-4 transactions till date, where the gains were very good. but the results are by far not representative.
I remember buffett mentioning that his and graham's result from arbitrage over a span of 40 years is around 20%.
i agree arbitrage is a lot of work for a part time investor, but i think it is a good approach to learn. It is a good approach to combine with valueinvesting especially for deep value stocks
regards
rohit
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