John S. Orrico, whose Arbitrage Fund trailed U.S. stock market benchmarks for the past two years, expects to revive his mutual fund's performance by concentrating investments in companies being bought for less than $1 billion.
Orrico, 44, and co-manager Matthew Hemberger, 46, are devoting about half of the fund's $268 million to these types of transactions. The fund buys shares of companies being acquired and holds them until the deals are completed. The risk is that the takeover agreements fall apart and the stocks drop.
"We want to play the smaller deals because you're more likely to see multiple bidders for a company, and spreads are potentially better," Orrico said in an interview from his office at Water Island Capital LLC in New York. "The sweet spot for us are deals between $200 million and $600 million."
The Arbitrage Fund is encountering its worst period of performance since the fund opened 4 1/2 years ago, falling 3.1 percent during the past 12 months. The fund lagged the 7.4 percent advance of the Standard & Poor's 500-stock index and the 1.3 percent gain of the competing Merger Fund.
To improve returns, Orrico is betting this year on deals such as Nanometrics Inc.'s $122 million agreement to merge with August Technology Corp. Shares of Bloomington, Minn.-based August, which makes equipment to test microchips, have gained 51 percent since Jan. 21 when the bid was announced.
A week later, Flanders, N.J.-based Rudolph Technologies Inc. offered $190 million for August, only to be topped by a $204.8 million cash bid from KLA-Tencor Corp. of San Jose, Calif., the world's biggest maker of semiconductor-inspection equipment.
"The bidding has yet to run its course," Orrico said. "That's the kind of deal we love."
More than 1,700 U.S. acquisitions valued at almost $241 billion have been announced so far this year, and 98 percent of them have been for less than $1 billion, according to data compiled by Bloomberg.
The Arbitrage Fund was hurt last year by investments in canceled or renegotiated deals involving such companies as Bethesda-based defense contractor Lockheed Martin Corp. and Tellabs Inc., a manufacturer of telephone network equipment.
Lockheed Martin's $1.7 billion proposed purchase of Titan Corp. collapsed during a criminal investigation over whether Titan consultants had bribed foreign officials. Tellabs in September cut the purchase price of fiber-optic-equipment maker Advanced Fibre Communications Inc. by 22 percent to about $1.5 billion after Advanced Fibre's profit fell.