Why Merger Arbitrage Now? To potentially mitigate risk1, provide downside protection2 and diversify returns3 in investors’ portfolios, this alternative investment strategy is arguably more important today than ever before.

ADVISED BY WATER ISLAND CAPITAL

Executive Summary Over the last several years, the merger arbitrage strategy, like many other alternative investment strategies, has struggled to deliver returns comparable with those generated by U.S. stock or bond indices. The reason is simple: since 2009, financial markets have been supported by unprecedented monetary stimulus by global central banks as well as by investors’ insatiable appetite for yield. These dynamics have created a market characterized by sustained low market volatility and low interest rates. At the same time, prices for risk assets, including stocks, corporate debt and sovereign bonds, marched ever higher, with little differentiation between good and questionable investments. Against a backdrop of muted volatility and robust gains in equities and fixed income markets, it is hard to appreciate or even recall the potential diversification benefits of alternative strategies such as merger arbitrage. The Standard and Poor’s 500 index has tripled since its March 2009 nadir; it has recorded six straight years of positive returns and its third consecutive year of double-digit gains in 2014. In fact, today’s bull market is the third longest in history. While one could argue that U.S. stocks are neither cheap nor expensive, we believe the current bull market shall nevertheless start to show its age. If history is any guide, equity markets are likely to be more turbulent in the periods ahead as growth rates and monetary policy around the world diverge. As for bonds, they are unlikely to be an investor’s “sleep tight at night” investment much longer. Although the current Wall Street consensus expectation is U.S. rates will be “lower for longer,” there is a possibility the U.S. Federal Reserve will begin to normalize rates by mid–2015. Bond prices may come under pressure should interest rate moves out-pace market expectations. Given these dynamics, investors are entering uncharted territory where bonds potentially fail to provide security in the face of rising rates and, after three years of complacency, volatility returns to equity markets. All of these concerns may make it prudent for investors to consider alternative investment strategies as a tool to buffer portfolio volatility and to preserve wealth. Merger arbitrage, in particular, has a proven history of providing diversifying and positive absolute returns in all market environments.

1

Reducing volatility is a common method of mitigating risk. Two common measures of risk are standard deviation, a measure of the dispersion of a set of data around its mean, and beta, a measure of the volatility of a portfolio to the market as a whole.

hfri merger arbitrage index

3-Year Standard Deviation: 1.87% 3-Year Beta vs. S&P 500: 0.10 3-Year Beta vs. Barclays Agg: 0.01 As of 12/31/14. Source: Morningstar.

2

Investments that outperform the broader market during periods of stress have the potential to act as a ballast and provide downside protection in a portfolio.

market peak to trough return HFRX Merger Arbitrage Index: +3.39% S&P 500: -54.89% Date range: 10/9/07-3/9/09. Source: Morningstar.

3

Portfolio returns can be diversified by investing in assets that are not correlated to the broader equity and fixed income markets.

hfri merger arbitrage index 3-Year Correlation vs. S&P 500: 0.50 3-Year Correlation vs. Barclays Agg: 0.02 As of 12/31/14. Source: Morningstar.

What makes merger arbitrage even more compelling today is that we believe the outlook for potential returns has improved significantly. Spreads on merger arbitrage deals have widened considerably since late October 2014, due in part to several high profile deal breaks and to a rise in market volatility from abnormally low levels. At the same time, transaction activity continues to make a strong resurgence. As this trickles down from mega-cap companies to the mid- and smaller-sized acquirers, the breadth of the deal universe expands leading to improved deal selection for arbitrageurs. Taken together, the investment environment suggests that investors reconsider the risk-adjusted return potential of an alternative investment strategy such as merger arbitrage.

The Arbitrage Funds

Why Merger Arbitrage Now? · 2

What is Merger Arbitrage? For decades, merger arbitrage, also commonly known as risk arbitrage, has been a meaningful component of institutional investors’ portfolios. This investment strategy focuses on profiting from capturing the discrepancy between the acquisition price and the price at which the target’s stock trades before consummation of a merger. This is commonly known as the “spread”. A spread strategy is intended to deliver returns that are isolated from the fluctuations of broader markets. Historically, investors added an allocation to merger arbitrage strategies to their portfolios to preserve wealth, dampen market risk and potentially augment and diversify return streams. During the wrenching tumult of the financial crisis of 2008 to 2009, when the S&P 500 index dropped by over 50% peak to trough, a thoughtfully constructed portfolio of merger arbitrage holdings generated returns that were not only independent of the market’s performance, but actually helped to preserve wealth by generating absolute positive performance.4 Post financial crisis, and in a zero interest rate environment, merger arbitrage has been embraced by investors seeking alternative sources of returns while also managing risk. Even though many merger arbitrage investors predominately utilize equities as the primary instrument to employ their strategy, and although most merger arbitrage portfolios focus on total return versus generating a steady stream of income, the risk/reward ratio of a diversified merger arbitrage portfolio is similar to short-term fixed income investments.5 These characteristics have led some asset allocators to view the strategy as a fixed income alternative.

The merger arbitrage strategy has been able to deliver consistent, absolute returns because of how the strategy is constructed.

4

The HFRX Merger Arbitrage Index returned +3.39% from October 7, 2007 through March 9, 2009, a period during which the S&P 500 Index lost -54.89%. Source: Morningstar.

5-year return

5

HFRI Merger Arbitrage Index: 3.05% HFRX Merger Arbitrage Index: 2.12% BAML 3-Month T-Bill Index: 0.10%

5-yr standard deviation HFRI Merger Arbitrage Index: 2.05% HFRX Merger Arbitrage Index: 2.48% BAML 3-Month T-Bill Index: 0.04%

5-yr sharpe ratio

Building Blocks of a Merger Arbitrage “Spread” Timing to Close

deal spread

• Steps in Process • Approvals Needed Deal Risk • • • •

Regulatory Financing Shareholder Votes Other Approvals or Consents

Risk-Free Rate • Short-Term Treasuries

}

HFRI Merger Arbitrage Index: 1.44 HFRX Merger Arbitrage Index: 0.83 BAML 3-Month T-Bill Index: 0.80 All figures are annualized. As of 12/31/14. Source: Morningstar.

Risk Premium + Risk-Free Rate = Deal Spread (i.e., Profit Potential)

Figure 1.

The Arbitrage Funds

Why Merger Arbitrage Now? · 3

What has happened since the Financial Crisis? Since late 2009, financial markets have been supported by unprecedented monetary stimulus by central banks coupled with investors’ insatiable appetite for yield. These dynamics have created markets characterized by historically outsized returns, sustained low volatility, low interest rates and an increasing appetite for risk. To put that in context, between 1928 and 2011, the S&P 500 has typically experienced a 10% decline once a year, according to Ned Davis Research. While there have been several episodes of market volatility during the past three years, none have resulted in a peak to trough market decline of more than 10%, and any decline of significance has not lasted more than a few days. What’s more, the S&P 500 index has gained 100% from October 2011 through December 2014, and in 2014 alone, it recorded 50 new highs. Meanwhile, for the past 30 years bond investors have experienced a near perfect environment of strong price appreciation. Since the Great Recession of 2008, yields have fallen to historically low levels. Under such a backdrop, it is not surprising that alternative strategies have struggled to deliver returns that are competitive to those generated by U.S. equity or bond indices. Subdued Results During Bull Runs, Ballast During Volatile Markets Not surprisingly, the recent environment has not been ideal for investment strategies that seek to generate returns independent of the broader markets’ performance. This is because in periods when prices for risk assets march ever higher without any sustained pullbacks and valuations become stretched, returns for alternative strategies are likely less attractive relative to the market. Most alternative strategies, such as merger arbitrage, are meant to capture returns that are more subdued than the market’s upside performance. On the other hand, when markets decline, an alternative strategy may potentially mute portfolio losses. Merger arbitrage strategies specifically should provide investors with protection from market shocks, thereby preserving wealth across market environments.

The Arbitrage Funds

Growth of $10,000 (1/1/95–12/31/14) $70,000 $60,000 $50,000 $40,000 $30,000 $20,000 $10,000 $0 Dec 1994

Dec 1999

Dec 2004

HFRI Merger Arb

Dec 2009

Barclays Aggregate

Dec 2014 S&P 500

Figure 2. Source: Morningstar. As of 12/31/14. Past performance is not a guarantee of future results. Index performance is not indicative of fund performance. One cannot invest directly in an index.

10-Year US Treasury Yield (1954-2014) 15%

10%

5%

0% 1954

1964

1974

1984

1994

2004

2014

Figure 3. Source: US Federal Reserve. Date range: 1/1/54-12/31/14. Past performance is not a guarantee of future results. Index performance is not indicative of fund performance. One cannot invest directly in an index.

Bull vs. Bear Market Annualized Returns HFRI Merger Arb

S&P 500

Barclays Agg

15%

26%

8%

Bear 1: Aug 00-Sep 02

2%

-25%

11%

Bull 2: Sep 02-Oct 07

8%

16%

4%

Bear 2: Oct 07-Feb 09

-5%

-41%

5%

Bull 3: Feb 09-Dec 14

4%

22%

5%

Bull 1: Dec 94-Aug 00

Figure 4. Source: Morningstar. As of 12/31/14. Past performance is not a guarantee of future results. Index performance is not indicative of fund performance. One cannot invest directly in an index.

Why Merger Arbitrage Now? · 4

Rates and Returns The risk-free rate (typically defined as the yield on the U.S. Government 3-Month Treasury Bill) is a critical component of merger arbitrage returns (see Figure 1). As a corresponding rule, unlevered merger arbitrage investors have traditionally sought to capture returns of 2-3 times this risk-free rate.

2,000

1,500

1,500

1,000

1,000

500

500

0

0 2014

2012

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2008

Deal Value

2006

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1998

1996

Another component of merger arbitrage returns is the number of transactions available in which to invest. The greater the number of deals spread across different industries and market capitalizations, the greater the opportunity set—which allows for a wider selection of high quality, strategic deals and lowers the potential for investing in transactions that don’t close. Since mid–2009, the nadir of the Great Recession, deal flow—in number, breadth and value—has been lackluster and concentrated in a select few industries. However, 2014 highlighted why it’s important to differentiate between a robust environment for merger and acquisition (M&A) activity and an ideal landscape for the merger arbitrage investment strategy. In terms of the dollar value of transactions, 2014 was the most active year since 2007. According to Dealogic, $3.6 trillion in transactions were announced globally in 2014. While we finally witnessed the return of animal spirits to corporate boardrooms, the headline number belies the fact that only a few industries (namely Health Care, Telecommunications and Media) have dominated deal flow and that most of the activity has been centered on mega-cap transactions—$20 billion plus—which usually have greater hurdles (primarily regulatory) for completion. What’s more, in 2014, nearly one-fifth of proposed mergers and acquisitions were terminated this year, representing about $700 billion in failed deals—the second most ever, according to Dealogic.

2,000

Deal Volume (#)

The Difference Between Deal Flow and Merger Arbitrage

Historical Deal Flow Deal Value ($B)

While impossible to predict future interest rates, we can say with no uncertainty that this historic yardstick of merger arbitrage returns has been artificially dislocated in the post-2008 era due to Central Bank policy.

2014 highlighted why it’s important to differentiate between merger and acquisition activity and the merger arbitrage strategy.

Deal Volume

Figure 5. Source: Dealogic. As of 12/31/14. Past performance is not a guarantee of future results.

An ideal environment for a merger arbitrage investment strategy would be characterized by a wide breadth of deal flow in mid and small market capitalization companies and participation across many sectors. This would lead to greater selection of high quality deals and more compelling spreads given greater market inefficiencies across capitalization levels.

The Arbitrage Funds

Why Merger Arbitrage Now? · 5

The Outlook for Mergers and Acquisitions The outlook for transaction activity and deal spreads improved markedly in the fall of 2014. As the efficacy of buybacks, dividend payouts, and other corporate actions plateau, strategically-sound M&A transactions should become the preferred maneuver to spur share price increases. Meanwhile, deal spreads, an indication of the potential performance of the merger arbitrage strategy, are wider (i.e., more attractive) than they have been in the past three years. In the spring of 2014, deal spreads averaged 4% on an annualized basis. At the end of 2014, deal spreads are annualizing at nearly 9%, according to UBS research. Accelerating market volatility and a few, high profile, terminated transactions expunged much of the speculation from the space. Furthermore, as the U.S. strengthens and the global economy stabilizes, boardroom confidence around the world usually grows. This should result in more transactions, across a wider swath of industries, geographies and market capitalizations, leading to a broader opportunity set of attractive, highquality M&A situations upon which arbitrageurs can capitalize. Why Invest in the Merger Arbitrage Strategy Now? Potential Wealth Preservation and Return Diversification The merger arbitrage strategy has typically been embraced for its wealth preservation and return diversification attributes. In the two most recent periods of extreme volatility, when equities last fell by double digits (see Figs. 5 and 6), merger arbitrage strategies performed better than both the broad equity market and the broader hedge fund universe. Given that today’s bull market is the third longest in history, investors may want to revisit the role of alternatives in their portfolios. The properties that make the merger arbitrage strategy an essential component of well-diversified portfolios are arguably more important than ever.

The Arbitrage Funds

Cumulative Return from Market Peak to Trough (10/31/07–2/28/09) 0% -10% -20% -30% -40% -50% -60% 10/07

2/08

6/08

HFRI Merger Arb

10/08

HFRI Composite

2/09 S&P 500

Figure 6. Source: Morningstar. Date range: 10/31/07-2/28/09. Past performance is not a guarantee of future results. Index performance is not indicative of fund performance. One cannot invest directly in an index.

Cumulative Return from Market Peak to Trough (4/30/11–9/30/11) 0% -4% -8% -12% -16% -20% 4/11

5/11

6/11

HFRI Merger Arb

7/11

8/11

HFRI Composite

9/11 S&P 500

Figure 7. Source: Morningstar. Date range: 4/30/11-9/30/11. Past performance is not a guarantee of future results. Index performance is not indicative of fund performance. One cannot invest directly in an index.

Average Annualized Deal Spreads 14% 12% 10% 8% 6% 4% 2% 0% Dec 13

Feb 13

Apr 13

Jun 14

Aug 14

Oct 14

Dec 14

Figure 8. Source:UBS Research. Date range: 12/31/13-12/31/14. Past performance is not a guarantee of future results.

Why Merger Arbitrage Now? · 6

Final Word Investors are entering uncharted territory where bonds potentially fail to provide security in the face of rising rates, and, after three years of doubledigit gains, equities become more volatile in response to divergent growth rates and monetary policies around the world. In light of this, it is prudent for investors to consider alternative investment strategies as a potential tool to buffer volatility and to preserve wealth. Merger arbitrage, in particular, has a history of providing diversifying and positive absolute returns during periods of market stress. What makes merger arbitrage even more compelling today is the outlook for potential returns has improved significantly. Spreads on merger arbitrage deals have widened considerably since late October 2014, due in part to several high profile deal breaks and a rise in market volatility to normalized levels. At the same time, deal-making activity continues to make a strong resurgence. As this trickles down from mega-cap companies to the mid- and smaller-sized acquirers, the breadth of the deal universe expands leading to improved deal selection for arbitrageurs.

It is always prudent for investors to consider alternative investment strategies as a potential tool to buffer volatility and to preserve wealth. Merger arbitrage, in particular, has a history of providing diversifying and positive absolute returns across all market environments.

Taken together, the investment environment strongly suggests that investors take another look at the risk-adjusted return potential of an alternative investment strategy such as merger arbitrage.

MERGER ARBITRAGE NOW We expect the following factors could have an impact on future returns generated by the strategy: volatility • In the recent low volatility environment, many investors have been willing to accept suboptimal returns relative to the risks they bear. • An increase in volatility in the fall of 2014, and a few, high profile terminated M&A transactions have expunged much of the speculation from the space. • Increased volatility will highlight the importance of deal selection. • The recent increase in volatility has provided the most attractive entry points for arbitrageurs seen in past three years. interest rates • Given the attempts by their respective central banks to stimulate the economies of Europe, Japan and China, non-U.S. interest rates are likely to stay low for the foreseeable future. • In the U.S., the Federal Reserve has indicated it may begin to increase interest rates by mid–2015. deal flow • With $3.6 trillion in announced deals, 2014 was the most active year for mergers and acquisitions since 2007. • As increases in deal activity trickle down from upper tier companies to mid/low tier acquirers, the breadth of the deal universe expands leading to improved deal selection for arbitrageurs. • Smaller cap deals also tend to have more certain timing and less regulatory risk, leading to higher quality investment opportunities • Deal flow will continue to increase as acquisitions become a preferred tool for share price appreciation replacing share buybacks, dividend increases and cost-cutting efforts. • Deal spreads, an indication of future potential performance of the strategy, are as wide, (i.e., attractive) as they have been in the past three years. In sum, the investment environment strongly suggests prudent investors consider the risk-adjusted return potential of an alternative investment strategy such as merger arbitrage.

The Arbitrage Funds

Why Merger Arbitrage Now? · 7

GLOSSARY basis point: A unit that is equal to 1/100th of 1%. bear market: A market condition in which the prices of securities are falling, and widespread pessimism causes the negative sentiment to be self-sustaining. beta: A measure of the volatility of a portfolio in relation to the market as a whole, indicates the tendency of a portfolio to respond to swings in the market. bull market: A financial market characterized by optimism and investor confidence, in which prices are rising or are expected to rise, with expectations that strong results will continue. correlation: A measure of how two securities move in relation to each other, ranging from -1 to +1. A correlation of 0 means the relationship between the two securities is completely random, while +1 indicates a perfect positive relationship and -1 a perfect negative relationship. DOJ: The United States Department of Justice is a department of the federal executive branch, headed by the attorney general, which administers the Federal Bureau of Investigation, prosecutes violations of federal law, and is responsible for enforcing all civil rights legislation. FTC: The Federal Trade Commission is an independent agency of the U.S. government with a principal mission of promoting consumer protection and the elimination and prevention of anticompetitive business practices, such as coercive monopoly. SEC: The Securities and Exchange Commission is a U.S. government commission created to regulate the securities markets and protect investors. In addition to regulation and protection, it also monitors corporate takeovers in the US. Sharpe ratio: A measure of risk-adjusted performance, calculated by subtracting the risk-free rate from the rate of return for a portfolio and dividing the result by the standard deviation of the portfolio returns. standard deviation: A measure of the degree of variation of returns around the average return.

IMPORTANT INFORMATION The Arbitrage Fund seeks to achieve capital growth by engaging in merger arbitrage. An investor should consider the Fund’s investment objectives, risks, charges and expenses carefully before investing. The current prospectus contains this and other information about the Fund. To obtain a prospectus, please call (800) 295-4485 or visit our website at http://arbitragefunds.com. Please read the prospectus carefully before investing. RISKS: The Fund uses investment techniques with risks that are different from the risks ordinarily associated with equity investments. Such techniques and strategies include merger arbitrage risks, high portfolio turnover risks, options risks, borrowing risks, short sale risks, and foreign investment risks, which may increase volatility and may increase costs and lower performance. Past performance is not a guarantee of future results. There is no guarantee that the strategy objectives will be met. The Standard and Poor’s 500 Index (“S&P 500”) is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy. The Barclays Capital U.S. Aggregate Bond Index (“Barclays Agg”) covers the U.S. investment grade fixed rate bond market. The Bank of America Merrill Lynch Three Month U.S. Treasury Bill Index (“BAML 3-Month T-Bill”) measures the performance of short-term U.S. government treasury bills. The HFRI and HFRX Merger Arbitrage Indices (“HFRI Merger Arb”/“HFRX Merger Arb”) include funds which employ an investment process primarily focused on opportunities in equity and equity related instruments of companies which are currently engaged in a corporate merger or acquisition transaction. The HFRI index is priced monthly, while the HFRX index is priced daily. The HFRI Fund Weighted Composite Index (“HFRI Composite”) is an equal-weighted index of over 2000 constituent hedge funds that invest over a broad range of strategies. Indexes are unmanaged and one cannot invest directly in an index. Index performance is not indicative of Fund performance. Distributed by ALPS Distributors Inc, which is not affiliated with the Water Island Capital (“the Adviser”) or any affiliates of the Adviser, Dealogic, Ned Davis Research, or UBS Research. [ARB000705 2016-05-01]