How to Make Money on Mergers

Funds that specialize in deal stocks can deliver steady returns without taking huge risks.

Investing in mergers is one of the safest ways to tiptoe into the stock market. We’re not kidding. Consider this case: Software giant Oracle plans to buy Sun Microsystems in a friendly, all-cash deal. Oracle will pay $9.50 for each share of the Silicon Valley computer-hardware firm. Yet Sun shares recently traded for about $8.60, or 10% below Oracle’s offer. Is this a free lunch just waiting to be served?

Sure looks that way. Say you were to buy Sun at the recent price, and the transaction, which awaits approval from European regulators, closes in four months. On an annualized basis, that 10% gap becomes a juicy 33% return, before trading commissions. But while nothing is stopping amateur investors from getting in on a deal like this, there are a lot of potential pitfalls. That’s why it’s a good idea to leave merger investing to specialists known as risk arbitrageurs. They sort through hundreds of deals like this one, investing in some and avoiding others. A handful of mutual funds that specialize in deals are known for providing steady returns and holding up well in bear markets.

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Contributing Editor, Kiplinger's Personal Finance