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Why Arbitragers Kept to Sidelines During MCA Deal

MCA Inc.'s $6.6-billion sellout to Matsushita ought to be a big victory for Wall Street’s arbitragers the professional traders whose specialty is betting on takeover deals. But in fact, many of the arbs say they’ll reap no windfall, because they didn’t buy MCA. It just never looked like an honest enough deal to them.

“I think the vast majority of professional arbitragers played that deal correctly--that is, they had very small positions or none at all,” argues Jeffrey Greenblatt, partner at the Baker, Nye Investments arb firm in New York.

For months, much of what was being said about MCA’s takeover potential “were things that just didn’t make sense,” Greenblatt says.

So the profits from the deal, instead, will flow to the cowboy speculators who took a chance on MCA armed with little more than hunch and hope.

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The arbs’ avoidance of MCA is a good commentary on the state of the stock market--and offers good reason why less-well-informed speculators will continue to be the main driving force in the market, with all of the attendant volatility that can cause for stocks.

Professional arbs are traders who make a living ferreting-out market information before it becomes well known. Takeovers have long been their bread and butter, for obvious reason. In the deal-crazy ‘80s, arbs played rumored takeover stocks with abandon and made huge profits.

But the 1987 stock crash and the 1989 collapse of the junk bond market killed off untold numbers of arbs by killing the deal game. And this year, one of the biggest anticipated takeovers--the buyout of United Airlines--collapsed, bloodying more arbs.

The arbs who are left are sober realists who have gone back to arbitrage’s roots: Rather than take a flyer on something, they wait for a deal to be announced. Then they try to determine what the target’s stock should be selling for, given the complexity of the deal and the time to completion.

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“It’s back to arbitrage as a systematic discipline again,” says Gene Cordon, partner at arb firm Mesirow Advanced Strategies in Highland Park, Ill. “Even those people who are more aggressive arb managers have become more cautious.”

What you see happening now with MCA stock is indeed traditional arbitrage. Thursday, 779,900 shares traded between $65.75 and $66. MCA closed at $65.875. Arbs know Matsushita will pay $66 a share in cash. What the pros are doing now is poring over research, trying to estimate the real value of the expected $5 in stock to be paid for MCA’s WWOR TV station. And they’re estimating how long the deal will take to be consummated.

If the final value of the deal is indeed $71 a share, a buyer at $66 will earn 7.6% before expenses. If the deal is completed in two months, as expected, that looks like a substantial annualized return. But to the arbs, that return is just adequate considering trading expenses, the chance of hitches developing and the uncertainties about valuing WWOR.

To the speculators who paid prices in the $40s or $50s for MCA in recent months, there’s no need to analyze MCA now. They stand to make a handsome profit. But those gunslingers could just as easily have been wrong, and lost their shirts.

Baker Nye’s Greenblatt says the “nature of the personalities involved” meant there was too much risk in MCA. And talk valuing MCA at $90 a share just raised the risk, Greenblatt says, because “I don’t think anybody who did analytical work believed those values would be achieved.”

So, many of the pros stepped away, and the amateur speculators took control. And that’s how it’s likely to stay in the bear market. That will mean more volatility, because speculators’ trigger fingers have replaced the arbs’ more deft touch.

Fund Investors Abandon Uncle Sam: In times of international turmoil, investors are supposed to seek safety in U.S. government securities. Somebody forgot to tell mutual fund investors about that concept.

October fund industry statistics, out Thursday, show a continuing outflow of cash from bond funds that invest in Treasury securities. Purchases of those funds totaled $1.01 billion for the month. Meanwhile, investors redeemed $1.46 billion of those funds’ shares, resulting in a net outflow of $447 million from the U.S. government funds.

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The outflow occurred even as investors generally showed bullishness about other bond funds and about stock funds. Overall, net purchases of bond funds totaled $1.4 billion in October, compared to $1.7 billion in September. Net purchases of stock funds totaled $1.1 billion, compared to $1.2 billion. While down for now, the ongoing net inflow of cash shows investors aren’t spooked by economic and war worries. If they were, they’d be liquidating like crazy.

So why are people cutting out of Treasury bond funds? Don Clark, officer at the Financial Programs fund family in Denver, argues that fund investors are simply showing their sophistication. Unlike in years past, “People are less inclined now to run for cover (during crises). They’re more inclined to look for buying opportunities,” he says.

Money is exiting Treasury funds because the 7% to 8% yields those funds pay look meager compared to returns elsewhere, fund officials say. Where the money is going:

* Bond and stock funds that invest in foreign securities. Global bond funds alone saw a net inflow of $711 million in October, and fund officials say those portfolios remain hot tickets this month. Many of the funds offer yields of 9% or better.

* U.S. stock funds, especially those investing for long-term growth. The market’s low in October just encouraged more bargain hunting. And that has continued in November, fund officials say. The Franklin Group of funds in San Mateo, Calif., says net stock fund purchases zoomed to $45 million in November from $4 million in October. Meanwhile, investors already in stock funds largely are staying put. At T. Rowe Price funds in Baltimore, spokesman Steve Norwitz says stock fund redemptions fell 50% in November from October.

* Tax-exempt municipal bond funds. With income tax rates rising, investors are realizing that tax-exempt muni yields of 6.5% to 7% are worth more than even 8.5% taxable Treasury yields.

Another sign that fund investors now are less worried about the Iraq situation and the economy: Fidelity Investments’ monthly survey of individual investors showed sentiment improved in November, after falling for five months. Fidelity’s sentiment index rose to 67.2 this month from 64.1 in October. The index, which measures investors’ optimism about the markets, was at 94.3 in June.

Briefly: From the Maybe-They-Should-Ask-Someone-Else Dept.: At the recent U.S. League of Savings Institutions convention, a Soviet official asked for U.S. advice in overhauling the U.S.S.R. Savings Bank.

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FUND INVESTORS’ MARKET VIEWS Here are mutual fund purchase, redemption and net cash inflow/outflow totals for key fund categories in October. The figures show investors remained positive on stocks, but yanked big money from U.S. government bond and junk bond funds. October data in (millions)

Stock Net inflow/ fund category Purchases Redemptions outflow Growth $1,138 $737 +$401 Growth and income 1,696 1,341 +355 International 463 217 +246 Aggressive growth 608 426 +182

Bond funds

Stock Net inflow/ fund category Purchases Redemptions outflow Global $825 $114 +$711 State municipals 1,009 539 +470 Municipal (genl.) 1,171 819 +352 GNMA 506 390 +116 High-yield (junk) 283 558 -275 U.S. government 1,012 1,459 -447

Source: Investment Company Institute


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