ABOUT The Merger Fund^®

OVERVIEW - INVESTMENT APPROACH

The Merger Fund^® seeks capital growth by investing the bulk of its assets in companies involved in pending mergers, takeovers and other corporate reorganizations. For most of its investments, the Fund's potential profit is equal to the difference between the price at which it acquires the target company's shares and their expected value upon completion of the transaction. Takeover stocks normally trade at a discount to the deal price because of the time value of money and the risk that the transaction won’t be consummated on its original terms or at all. The size of this discount, known as the arbitrage "spread," is influenced both by general market conditions and by deal-specific considerations that affect the transaction's timing and perceived probability of success.

When investing in an all-cash takeover, the Fund typically attempts to capture the arbitrage spread by establishing a long position in the target company's shares following the deal's announcement—we never invest on rumors. The position is generally held until the deal closes, at which point the target's shares are exchanged for cash. The Fund's holding period may range from a few months to well over a year, although most of the Fund's gains are short-term in nature.

When investing in a stock-for-stock merger involving a fixed exchange ratio, the Fund normally combines a long position in the target with a short position in the acquirer. In this way the Fund is able to "lock in" the arbitrage spread between the two securities and is indifferent to fluctuations in the acquirer's stock price during the pendency of the transaction. Upon completion of the merger, shares in the target are exchanged for the acquirer's shares, and the short position is closed out.

Risk management is more than just a buzzword at The Merger Fund^®. Capital preservation has always been high on our list of priorities, and the Fund's managers go to great lengths to protect the portfolio against outsized losses. The Fund's risk-management process begins with a disciplined, research-intensive approach to deal selection. Not all arbitrage opportunities offer the risk-reward profile the Fund requires. Moreover, because merger arbitrage is an extremely dynamic investment approach, a simple buy-and-hold strategy for those deals that do pass muster would not serve the interests of our shareholders. The Fund's holdings are constantly being adjusted as stock prices change and new information becomes available. In "right-sizing" positions on a day-to-day basis, the Fund's managers rely on the judgment that comes from having invested in more than 2,500 mergers and takeovers. They also rely on an advanced suite of quantitative portfolio-management tools that allow them to rank each deal in the Fund's investment universe and determine the price at which they would buy or sell any given stock.

Portfolio diversification is another important element of the Fund's risk-management strategy. No matter how much we like a particular arbitrage situation, we won't bet the ranch on it. The Merger Fund^® also routinely employs a variety of hedging strategies to limit market-related risk. Some of these hedges are deal-specific, while others are designed to help insulate the portfolio from unfavorable market conditions that could have a negative effect on arbitrage spreads in general. With these hedges in place, the principal risk associated with the Fund’s merger-arbitrage strategy is that certain of the proposed reorganizations in which the Fund invests may be renegotiated or terminated, in which case losses may be realized. Assessing deal risk, of course, is one of our core competencies.

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