UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED
MANAGEMENT INVESTMENT COMPANIES
Investment Company Act file number 811-21279
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THE MERGER FUND VL
------------------
(Exact name of registrant as specified in charter)
100 SUMMIT LAKE DRIVE
VALHALLA, NEW YORK 10595
------------------------
(Address of principal executive offices) (Zip code)
BONNIE L. SMITH
THE MERGER FUND VL
100 SUMMIT LAKE DRIVE
VALHALLA, NEW YORK 10595
------------------------
(Name and address of agent for service)
1-800-343-8959
--------------
Registrant's telephone number, including area code
Date of fiscal year end: DECEMBER 31
-----------
Date of reporting period: DECEMBER 31, 2005
-----------------
ITEM 1. REPORTS TO STOCKHOLDERS.
- --------------------------------
THE MERGER FUND VL
ANNUAL REPORT
DECEMBER 31, 2005
February 14, 2006
Dear Fellow Shareholder:
As previously reported, The Merger Fund VL showed a gain of 4.5% in the 12
months ended December 2005. A healthy level of M&A activity provided the Fund
with a tailwind during much of the year, but we did encounter a few pockets of
turbulence in the form of troubled deals. While respectable, the Fund's
performance fell a little short of our rate-of-return targets. Nonetheless,
since its inception almost two years ago, The Merger Fund VL has shown solid
results and far less volatility than conventional equity mutual funds.
As is customary in these annual reports, we have included a series of charts
which reflect the nature of the arbitrage opportunities in which the Fund has
recently invested. Chart 1 shows that as of December 31, friendly transactions
represented almost 95% of the dollar value of our equity holdings, while
unsolicited, or hostile, takeover attempts accounted for slightly more than 5%.
The latter figure, which is about the same as it was a year earlier, indicates
that hostile deals continue to make up a relatively small percentage of total
M&A activity. Many would-be acquirers apparently have concluded that friendly
takeovers are hard enough to get right and that hostile deals are even more
problematic. Such concerns are well-founded. As we have noted on numerous
occasions over the years, for a hostile takeover attempt to succeed, the stars
must be in perfect alignment for the bidder, and such opportunities come around
about as often as Halley's Comet. Not only are target companies routinely
protected by poison pills, staggered boards and other takeover defenses that
have withstood legal challenge, but many companies have also chosen to be
legally domiciled in states whose corporate-governance statutes are especially
unfriendly to hostile suitors. Presumed by the courts to be acting in their
shareholders' best interests, corporate boards are generally free to reject
unsolicited offers out of hand, even richly valued bids that would have the
support of those very same shareholders. Only a highly motivated acquirer
willing to wage a protracted battle can hope to prevail against the "just say
no" defense, and even with such a commitment, victory is not assured; at the
eleventh hour, a white knight may agree to pay more and steal the prize. In
last year's annual report, we wrote about Oracle's dogged pursuit of PeopleSoft,
an effort that eventually succeeded but only after the buyer invested 19 months
in the process. This year's award for the most-persistent suitor goes to
Omnicare, which finally was able to acquire rival NeighborCare after a struggle
that lasted 14 months. To put this award in perspective, however, there were
very few other candidates.
Chart 2 shows that approximately 92% of the acquisitions in which the Fund
has recently invested are strategic in nature, meaning combinations that involve
a corporate buyer-typically operating in the same industry as the target-whose
objective in doing the transaction is to enhance shareholder value on a longer-
term basis. The rest are financial deals. These are mostly going-private
transactions in which an investor group that includes the target's management
uses large amounts of borrowed money to buy out the public shareholders. In
most cases, the goal in such highly leveraged deals is to pay down debt and then
either sell or IPO the company, ideally within a relatively short time frame of
just a few years. Owing in large part to the vast pile of cash available for
these kinds of transactions, financial players were increasingly active last
year. On a global basis, buyout firms are estimated to have raised more than
$250 billion in equity capital in 2005 alone, and a similar amount could be
raised this year. These funds can be leveraged several times over with debt
financing. Moreover, the increased willingness of financial buyers to work
together on certain deals-seven private-equity firms took part in the $11
billion purchase of SunGard Data Systems-means that even larger targets can be
pursued, with the result that relatively few publicly traded companies are too
big to be taken private. These "club" deals also help to avoid bidding contests
among private-equity shops. Another reason for the continued strength in going-
private deals is that a growing number of corporate executives have become
frustrated with the burdens of public ownership, including compliance with
Sarbanes-Oxley, an unprecedented degree of scrutiny by regulators and the
financial press, shareholder activism and Wall Street's obsession with short-
term results. For these executives, the choice between continuing to operate in
a goldfish bowl and taking a shot at making serious money with a successful LBO
may not be that close a call. From a merger-arbitrage perspective, we tend to
prefer strategic deals to LBOs because the latter have historically been a
little more accident-prone, and we adjust our rate-of-return requirements
accordingly.
Chart 3 shows the type of consideration to be received by the selling
company's shareholders in transactions in which The Merger Fund VL held
positions at the end of December. This year's chart shows that when it comes to
deal-making, cash is king. Mergers and acquisitions involving at least some
cash make up over 90% of the Fund's portfolio, while all-stock transactions
account for just 5%, down from 15% a year ago. The growing preference for cash
can be explained by the same factors that we discussed in last year's annual
report: the reluctance of many acquirers to issue new shares at what they
consider to be unattractive price levels; the fact that takeovers are often more
accretive to the buyer's bottom line when done as all-cash deals, especially
when borrowing costs remain relatively low; the upturn in going-private
transactions, in which the target's shareholders receive only cash; and the
preference of some sellers for cash deals, whose value is unaffected by
fluctuations in equity prices. Another factor is at work this year. Corporate
balance sheets are bulging with cash, and using a portion of it to make
acquisitions may be a strategically attractive option for many companies.
Spending excess cash for takeovers can serve another purpose, as well. Cash-
heavy balance sheets sometimes attract activist shareholders who demand large
stock buybacks or special dividends, options that may not be in the company's
best interests on a longer-term basis. In evaluating potential arbitrage
investments for the Fund, the mix of cash and stock to be received is generally
not that important to us, but deal terms do impact our hedging strategies. When
investing in stock-for-stock mergers with fixed exchange ratios, we attempt to
lock in the arbitrage spread by selling short the acquirer's shares at the same
time that a long position is established in the target. In this way, the Fund
is hedged against a decline in the acquirer's stock price prior to the close of
the transaction.
Chart 4 shows our investments grouped by economic sector. The Fund's
holdings continue to be fairly well diversified, with the largest sector
accounting for about 20% of the portfolio. For the second year in a row,
healthcare deals represent the largest percentage of our investments, followed
by the telecommunications sector at about 17%. The financial-services sector,
historically a fertile area for M&A, has moved into third place. Because we
take a "bottom up" approach to deal selection, the issues that are specific to a
given merger or takeover tend to play a much greater role in our analysis than
such "macro" factors as the sector in which the companies operate. Having said
that, we do attempt to diversify our investments by industry group in order to
make the Fund less vulnerable to systemic risk, or the risk that unexpected
industry-specific events could adversely impact a number of pending deals at the
same time.
Chart 5 shows the Fund's arbitrage investments grouped by the geographic
region in which the target company is domiciled. At the end of 2005,
approximately 83% of the deals in our portfolio involved U.S.-based targets,
while 17% involved targets located in Canada and Europe. A year earlier, non-
U.S. deals accounted for about the same percentage of our investments. Although
The Merger Fund VL has the resources and expertise to invest globally, we
recognize that foreign deals play out against a different political, corporate-
governance and regulatory backdrop than comparable transactions in the U.S., and
the Fund won't invest overseas unless we have done our homework and have a firm
handle on the risks involved. Speaking of risks, the Fund routinely hedges the
currency risk in cross-border deals, so that fluctuations in exchange rates
rarely have a material impact on our returns.
Chart 6 shows the total dollar value of mergers and acquisitions in the U.S.,
by quarter, since 1991. The chart indicates that M&A activity has recovered
smartly from the depressed levels of 2002 but remains well below the record pace
seen in the 1998-2000 period, when the annual volume of corporate
reorganizations averaged close to $1.5 trillion. Of the many reasons for the
recent strength in deal-making, probably the most important is the return of
confidence to corporate boardrooms. A few years ago, executives had to deal
with the aftermath of 9/11 and the attendant economic and geopolitical
uncertainties. At about the same time, a wave of accounting scandals raised
questions about the adequacy of Corporate America's financial controls, and
directors were reluctant to greenlight acquisitions until they could be assured
that their own house was in order and that the financial statements of potential
targets could be relied upon. Now that the U.S. economy has shown its
resiliency-even in the face of record trade and budget deficits and soaring
energy prices-and accounting-related concerns have been addressed, executives
are better able to focus on how to position their companies for the long term.
This is a process that often involves consideration of mergers, acquisitions or
some other type of corporate reorganization. Investment bankers have another
reason to be optimistic these days. An increasing number of newly announced
transactions are being well-received by investors. Transformational deals that
take the acquirer in an entirely new direction or acquisitions dependent on
aggressive assumptions regarding revenue synergies are still a hard sell, but
straightforward combinations that promise realistic cost savings are now often
given the benefit of the doubt, especially if the takeover premium is not too
generous. Absent an external shock to the system, we expect that M&A activity
will remain strong and that the Fund will have a good supply of new deals in
which to invest.
Sincerely,
/s/Frederick W. Green
Frederick W. Green
President
CHART 1
PORTFOLIO COMPOSITION
BY TYPE OF DEAL*<F1>
FRIENDLY 94.9%
HOSTILE 5.1%
CHART 2
PORTFOLIO COMPOSITION
BY TYPE OF BUYER*<F1>
STRATEGIC 92.1%
FINANCIAL 7.9%
CHART 3
PORTFOLIO COMPOSITION
BY DEAL TERMS*<F1>
STOCK WITH FIXED EXCHANGE RATIO 2.0%
STOCK WITH FLEXIBLE EXCHANGE RATIO 3.2%
CASH & STOCK 35.6%
CASH 54.6%
UNDETERMINED 4.6%
*<F1> Data as of December 31, 2005
CHART 4
PORTFOLIO COMPOSITION
BY SECTOR*<F2>
HEALTHCARE 20.7%
TELECOMMUNICATIONS 16.9%
FINANCIAL SERVICES 16.4%
TECHNOLOGY 12.2%
ENERGY 10.0%
MEDIA & ENTERTAINMENT 6.8%
BUSINESS SERVICES 4.7%
CONSUMER NON-DURABLES 3.9%
CONSUMER SERVICES 3.7%
BASIC INDUSTRIES 2.9%
CONSUMER DURABLES 1.8%
CHART 5
PORTFOLIO COMPOSITION
BY REGION*<F2>
UNITED STATES 83.4%
EUROPE 12.8%
CANADA 3.8%
*<F2> Data as of December 31, 2005
CHART 6
MERGER ACTIVITY
1991 - 2005
Year First Quarter Second Quarter Third Quarter Fourth Quarter
- ---- ------------- -------------- ------------- --------------
1991 $19.9516 $20.5286 $27.3834 $16.3747
1992 $16.6579 $30.7912 $16.1062 $20.9834
1993 $20.3626 $30.0446 $72.4562 $64.2678
1994 $43.9419 $41.2508 $79.3201 $58.3516
1995 $63.2519 $109.5822 $138.6244 $92.8259
1996 $81.5836 $147.5119 $114.5835 $180.8346
1997 $157.8150 $135.3298 $146.4147 $247.8092
1998 $207.8147 $667.8133 $273.4782 $271.3921
1999 $344.2760 $473.5610 $227.3533 $495.8469
2000 $495.6549 $238.7511 $432.3114 $264.6629
2001 $161.5246 $138.7080 $154.2153 $121.5994
2002 $45.7014 $60.8711 $95.8875 $44.3849
2003 $36.7571 $57.2983 $72.9279 $161.5566
2004 $250.4977 $109.3510 $99.8604 $186.5095
2005 $215.1986 $225.5347 $134.1715 $214.4662
Source: Securities Data Corp.
COMPARISON OF CHANGE IN VALUE OF $10,000 INVESTMENT
IN THE MERGER FUND VL AND THE S&P 500
Date The Merger Fund VL S&P 500
---- ------------------ -------
5/26/2004*<F3> $10,000 $10,000
6/30/2004 $9,990 $10,248
9/30/2004 $10,080 $10,057
12/31/2004 $10,600 $10,985
3/31/2005 $10,710 $10,749
6/30/2005 $10,900 $10,896
9/30/2005 $11,160 $11,289
12/31/2005 $11,081 $11,525
*<F3> Inception Date 5/26/04
AVERAGE ANNUAL
TOTAL RETURN
--------------
The Merger Fund VL 4.53%
The Standard & Poor's 500 Index (S&P 500) is a capitalization-weighted index,
representing the aggregate market value of the common equity of 500 stocks
primarily traded on the New York Stock Exchange. This chart assumes an initial
gross investment of $10,000 made on May 26, 2004. Returns shown include the
reinvestment of all dividends. Past performance is not predictive of future
performance. The graph and table do not reflect the deduction of taxes that a
shareholder would pay on fund distributions or the redemption of fund shares.
Investment return and principal value will fluctuate, so that your shares, when
redeemed, may be worth more or less than the original cost.
THE MERGER FUND VL
EXPENSE EXAMPLE
DECEMBER 31, 2005
As a shareholder of the Fund, you incur ongoing costs, including management fees
and other Fund expenses. This example is intended to help you understand your
ongoing costs (in dollars) of investing in the Fund and to compare these costs
with the ongoing costs of investing in other mutual funds. The example is based
on an investment of $1,000 for the period 7/1/05 - 12/31/05.
ACTUAL EXPENSES
The first line of the table below provides information about actual account
values and actual expenses. To the extent the Fund invests in shares of other
investment companies as part of its investment strategy, you will indirectly
bear your proportionate share of any fees and expenses charged by the underlying
funds in which the Fund invests in addition to the expenses of the Fund. Actual
expenses of the underlying funds are expected to vary among the various
underlying funds. These expenses are not included in the example below. The
example below includes, but is not limited to, management fees, fund accounting,
custody and transfer agent fees. However, the example below does not include
portfolio trading commissions and related expenses, and other extraordinary
expenses as determined under generally accepted accounting principles. You may
use the information in this line, together with the amount you invested, to
estimate the expenses that you paid over the period. Simply divide your account
value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6),
then multiply the result by the number in the first line under the heading
entitled "Expenses Paid During Period" to estimate the expenses you paid on your
account during this period.
HYPOTHETICAL EXAMPLE FOR COMPARISON PURPOSES
The second line of the table below provides information about hypothetical
account values and hypothetical expenses based on the Fund's actual expense
ratio and an assumed rate of return of 5% per year before expenses, which is not
the Fund's actual return. The hypothetical account values and expenses may not
be used to estimate the actual ending account balance or expenses you paid for
the period. You may use this information to compare the ongoing costs of
investing in the Fund and other funds. To do so, compare this 5% hypothetical
example with the 5% hypothetical examples that appear in the shareholder reports
of the other funds. Please note that the expenses shown in the table are meant
to highlight your ongoing costs only and do not reflect any transactional costs,
such as redemption fees. Therefore, the second line of the table is useful in
comparing ongoing costs only, and will not help you determine the relative total
costs of owning different funds. In addition, if these transactional costs were
included, your costs would have been higher.
BEGINNING ACCOUNT ENDING ACCOUNT EXPENSES PAID DURING
VALUE 7/1/05 VALUE 12/31/05 PERIOD 7/1/05 - 12/31/05*<F8>
----------------- -------------- -----------------------------
Actual +<F4> (1)<F6> $1,000.00 $1,016.60 $14.13
Hypothetical ++<F5> (2)<F7> $1,000.00 $1,011.19 $14.09
+<F4> Excluding dividends on short positions and interest expense, your
actual cost of investment in the Fund would be $7.12.
++<F5> Excluding dividends on short positions and interest expense, your
hypothetical cost of investment in the Fund would be $7.12.
(1)<F6> Ending account values and expenses paid during period based on a
1.66% return. This actual return is net of expenses.
(2)<F7> Ending account values and expenses paid during period based on a
5.00% annual return before expenses.
*<F8> Expenses are equal to the Fund's annualized expense ratio of 2.78%,
multiplied by the average account value over the period, multiplied
by 184/365 (to reflect the one-half year period).
THE MERGER FUND VL
SCHEDULE OF INVESTMENTS
DECEMBER 31, 2005
SHARES VALUE
------ -----
COMMON STOCKS -- 121.02%
APPAREL MANUFACTURERS -- 4.65%
4,450 Reebok International Ltd. (f)<F14> $ 259,123
----------
APPAREL RETAILING -- 2.97%
8,700 J. Jill Group Inc. (a)<F9> (c)<F11> 165,561
----------
AUTOMOTIVE PARTS & EQUIPMENT -- 2.37%
7,650 Titan International, Inc. (f)<F14> 131,963
----------
BANKING -- 0.00%
1 Zions Bancorporation 76
----------
BROADCASTING -- 1.52%
6,150 Lin TV Corp -- Class A (a)<F9> 68,511
1,038 News Corporation -- Class A 16,141
----------
84,652
----------
BROKERAGE SERVICES -- 3.41%
37,400 Instinet Group
Incorporated (a)<F9> (c)<F11> (h)<F16> 190,295
----------
CABLE TV -- 6.08%
5,050 Cablevision Systems
Corporation (a)<F9> (d)<F12> 118,523
9,250 Telewest Global, Inc. (a)<F9> (g)<F15> 220,335
----------
338,858
----------
COMPUTER SOFTWARE -- 6.75%
2,400 Geac Computer Corporation Limited (a)<F9> 26,160
11,800 Intellisync Corporation (a)<F9> 60,888
6,125 Micromuse, Inc. (a)<F9> 60,576
21,600 Siebel Systems, Inc. (g)<F15> 228,528
----------
376,152
----------
CONSUMER FINANCE -- 4.75%
9,750 MBNA Corporation (e)<F13> 264,712
----------
DATABASE MARKETING SERVICES -- 0.23%
1,177 infoUSA, Inc. (f)<F14> 12,865
----------
DEFENSE ELECTRONICS -- 2.99%
4,000 Engineered Support Systems, Inc. (f)<F14> 166,560
----------
DIALYSIS PRODUCTS & SERVICES -- 3.39%
4,000 Renal Care Group, Inc. (a)<F9> (f)<F14> 189,240
----------
E-COMMERCE -- 0.13%
863 Emdeon Corporation (a)<F9> 7,301
----------
FOOD & BEVERAGES -- 0.41%
850 Vincor International Inc. (a)<F9> 22,646
----------
FOOD RETAILING -- 1.80%
4,700 Albertson's, Inc. (d)<F12> 100,345
----------
HEALTHCARE FACILITIES -- 1.76%
8,400 Beverly Enterprises, Inc. (a)<F9> (e)<F13> 98,028
----------
INFORMATION TECHNOLOGY -- 3.08%
2,600 Anteon International Corporation (a)<F9> (f)<F14> 141,310
600 Computer Sciences Corporation (a)<F9> 30,384
----------
171,694
----------
INTEGRATED GAS & ELECTRIC COMPANIES -- 2.27%
2,200 Constellation Energy Group (f)<F14> 126,720
----------
LOTTERY SERVICES -- 4.21%
7,400 GTECH Holdings Corporation (d)<F12> 234,876
----------
MEDICAL DEVICES -- 11.79%
5,700 Animas Corp. (a)<F9> (f)<F14> 137,655
4,500 Guidant Corporation (c)<F11> 291,375
2,600 INAMED Corporation (a)<F9> (c)<F11> 227,968
----------
656,998
----------
MEDICAL INFORMATION SYSTEMS -- 4.08%
1,500 IDX Systems Corporation (a)<F9> 65,880
8,400 NDCHealth Corporation (a)<F9> (e)<F13> 161,532
----------
227,412
----------
METALS & MINING -- 0.78%
1,900 Placer Dome, Inc. (g)<F15> 43,567
----------
NETWORKING PRODUCTS -- 1.74%
7,300 Enterasys Networks, Inc. (a)<F9> 96,944
----------
OIL & GAS EXPLORATION & PRODUCTION -- 10.71%
3,833 Burlington Resources, Inc. (d)<F12> 330,405
5,000 Vintage Petroleum, Inc. (f)<F14> 266,650
----------
597,055
----------
PHARMACEUTICALS -- 5.76%
6,488 Abgenix, Inc. (a)<F9> (f)<F14> 139,557
5,800 IVAX Corporation (a)<F9> (c)<F11> 181,714
----------
321,271
----------
REAL ESTATE INVESTMENT TRUSTS -- 7.44%
4,000 Arden Realty, Inc. (f)<F14> $ 179,320
2,300 CenterPoint Properties Trust 113,804
2,990 Prentiss Properties Trust (f)<F14> 121,633
----------
414,757
----------
SATELLITE COMMUNICATIONS -- 5.20%
6,000 New Skies Satellites Holdings Ltd. (f)<F14> 130,620
6,500 PanAmSat Holding Corp. (f)<F14> 159,250
----------
289,870
----------
SAVINGS & LOANS -- 2.00%
2,800 Independence Community Bank Corp. (c)<F11> 111,244
----------
STEEL -- 3.01%
3,000 Dofasco, Inc. (d)<F12> 167,698
----------
TELECOMMUNICATIONS EQUIPMENT -- 2.90%
3,750 Scientific-Atlanta, Inc. (g)<F15> 161,512
----------
TELEPHONY -- 12.84%
6,000 Alamosa Holdings, Inc. (a)<F9> (f)<F14> 111,660
5,100 MCI, Inc. (e)<F13> 100,623
6,000 Nextel Partners, Inc. (a)<F9> (f)<F14> 167,640
15,345 Price Communications Corporation (a)<F9> (f)<F14> 228,180
1,800 TDC A/S (f)<F14> 107,823
----------
715,926
----------
TOTAL COMMON STOCKS (Cost $6,689,376) 6,745,921
----------
CONTRACTS (100 SHARES PER CONTRACT)
- -----------------------------------
PUT OPTIONS PURCHASED -- 0.02%
11 DRS Technologies
Expiration: March, 2006, Exercise Price: $45.00 962
----------
TOTAL PURCHASED OPTIONS (Cost $1,334) 962
----------
PRINCIPAL
AMOUNT
- ---------
CORPORATE BONDS -- 3.42%
Adelphia Communications Corporation
$ 24,000 9.375%, 11/15/2009 (b)<F10> 14,160
219,000 10.250%, 06/15/2011 (b)<F10> 132,495
55,000 Toys "R" Us, Inc.
7.875%, 04/15/2013 44,000
----------
TOTAL CORPORATE BONDS (Cost $238,979) 190,655
----------
TAX ESCROW NOTE -- 0.06%
4,979 NextWave Wireless LLC Secured Note 3,236
----------
TOTAL TAX ESCROW NOTE (Cost $2,738) 3,236
----------
SHORT-TERM INVESTMENTS -- 0.03%
VARIABLE RATE DEMAND NOTES -- 0.03%
1,643 U.S. Bank, 4.130% 1,643
----------
TOTAL SHORT-TERM INVESTMENTS (Cost $1,643) 1,643
----------
TOTAL INVESTMENTS (Cost $6,934,070) $6,942,417
----------
----------
Percentages are stated as a percent of net assets.
(a)<F9> Non-Income producing security.
(b)<F10> Security in default.
(c)<F11> All or a portion of the shares have been committed as collateral for
open short positions.
(d)<F12> All or a portion of the shares have been committed as collateral for
written option contracts.
(e)<F13> All or a portion of the shares have been committed as collateral for
equity swap positions.
(f)<F14> All or a portion of the shares have been committed as collateral for
the credit facility.
(g)<F15> All or a portion of the shares have been committed as collateral for
short foreign currency contracts.
(h)<F16> Fair-valued security.
See notes to the financial statements.
THE MERGER FUND VL
SCHEDULE OF SECURITIES SOLD SHORT
DECEMBER 31, 2005
SHARES VALUE
------ -----
1,200 Allergan, Inc. $ 129,552
4,900 Bank of America Corporation 226,135
1,350 Barrick Gold Corporation 37,624
2,150 Brandywine Realty Trust 60,007
1,825 ConocoPhillips 106,179
1,700 Johnson & Johnson 102,170
1,040 News Corporation - Class B 17,274
1,075 NTL Incorporated 73,186
2,150 Occidental Petroleum Corporation 171,742
1,900 Per-Se Technologies, Inc. 44,384
2,493 Teva Pharmaceutical Industries, Ltd. -- ADR 107,224
2,875 Verizon Communications Inc. 86,595
----------
TOTAL SECURITIES SOLD SHORT
(Proceeds $1,127,598) $1,162,072
----------
----------
ADR - American Depository Receipt
See notes to the financial statements.
THE MERGER FUND VL
SCHEDULE OF OPTIONS WRITTEN
DECEMBER 31, 2005
CONTRACTS (100 SHARES PER CONTRACT) VALUE
- ----------------------------------- -----
CALL OPTIONS
67 Albertson's, Inc. $ 2,010
Expiration: January, 2006, Exercise Price: $22.50
13 Burlington Resources, Inc. 14,820
Expiration: January, 2006, Exercise Price: $75.00
4 Cablevision Systems Corporation 580
Expiration: January, 2006, Exercise Price: $22.50
6 Computer Sciences Corporation 990
Expiration: January, 2006, Exercise Price: $50.00
20 Constellation Energy Group 400
Expiration: January, 2006, Exercise Price: $60.00
24 Dofasco, Inc. 10,302
Expiration: January, 2006, Exercise Price: $60.00
6 Dofasco, Inc. 1,585
Expiration: January, 2006, Exercise Price: $62.00
44 GTECH Holdings Corporation 10,120
Expiration: January, 2006, Exercise Price: $30.00
9 Guidant Corporation 1,800
Expiration: January, 2006, Exercise Price: $65.00
37 Scientific-Atlanta, Inc. 555
-------
Expiration: January, 2006, Exercise Price: $45.00
TOTAL OPTIONS WRITTEN
(Premiums received $60,157) $43,162
-------
-------
See notes to the financial statements.
THE MERGER FUND VL
STATEMENT OF ASSETS AND LIABILITIES
DECEMBER 31, 2005
ASSETS:
Investments, at value (Cost $6,934,070) $6,942,417
Deposit at brokers for short sales 331,700
Cash 84,039
Receivable from brokers for proceeds on securities sold short 1,122,309
Receivable for investments sold 696,771
Receivable for written options 2,085
Receivable from investment adviser 19,657
Dividends and interest receivable 9,602
----------
Total Assets 9,208,580
----------
LIABILITIES:
Securities sold short, at
value (Proceeds of $1,127,598) $1,162,072
Options written, at value
(Premiums received $60,157) 43,162
Loan Payable 1,388,000
Payable for forward currency exchange contracts 58
Payable for equity swap contracts 4,937
Payable for dividends on securities sold short 3,105
Payable for investment securities purchased 948,864
Payable for fund shares redeemed 908
Accrued expenses and other payables 83,512
----------
Total Liabilities 3,634,618
----------
NET ASSETS $5,573,962
----------
----------
NET ASSETS Consist Of:
Accumulated undistributed net realized
gain on investments sold $ 236,115
Undistributed net investment loss (900)
Net unrealized appreciation (depreciation) on:
Investments $ 8,347
Short positions (34,474)
Written options 16,995
Equity swap contracts (8,356)
Foreign currency translation (3)
Forward currency exchange contracts (58)
----------
Net unrealized depreciation (17,549)
Paid-in capital 5,356,296
----------
Total Net Assets $5,573,962
----------
----------
NET ASSET VALUE, offering price and redemption price per share
($5,573,962 / 508,400 shares of beneficial interest outstanding) $10.96
------
------
See notes to the financial statements.
THE MERGER FUND VL
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2005
INVESTMENT INCOME:
Interest $ 34,476
Dividend income on long positions
(net of foreign withholding taxes of $537) 43,508
--------
Total investment income 77,984
--------
EXPENSES:
Investment advisory fee $ 53,355
Interest expense 22,023
Transfer agent and shareholder servicing agent fees 65,740
Federal and state registration fees 730
Professional fees 89,025
Trustees' fees and expenses 12,485
Custody fees 1,580
Administration fee 40,150
Reports to shareholders 7,967
Miscellaneous expenses 2,500
Dividends on short positions (net of
foreign withholding taxes of $51) 20,381
---------
Total operating expenses 315,936
Less: Expenses reimbursed (Note 3) (213,775)
--------
Total expenses 102,161
--------
NET INVESTMENT LOSS (24,177)
--------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Realized gain (loss) on:
Long transactions 225,760
Short transactions (101,373)
Option contracts expired or closed 85,293
Equity swap contracts 53,342
Foreign currencies (1,536)
---------
Net realized gain 261,486
Change in unrealized appreciation / depreciation on:
Investments (33,268)
Short positions (13,819)
Written options 17,942
Equity swap contracts (8,962)
Foreign currency translation (3)
Forward currency exchange contracts 1,296
---------
Net unrealized loss (36,814)
--------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS 224,672
--------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $200,495
--------
--------
See notes to the financial statements.
THE MERGER FUND VL
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2005
CASH PROVIDED (USED) BY FINANCING ACTIVITIES:
Sales of capital shares $ 4,386,248
Repurchases of capital shares (374,314)
Net change in receivables / payables related
to capital share transactions 665
------------
Cash provided by capital share transactions 4,012,599
Proceeds from borrowings 1,388,000
------------
$5,400,599
----------
CASH PROVIDED (USED) BY OPERATIONS:
Purchases of investments:
Long transactions (39,404,762)
Short transactions (6,320,640)
Written options (126,431)
Foreign currencies (569,947)
Forward contracts (5,776,620)
------------
(52,198,400)
------------
Proceeds from sales of investments:
Long transactions 33,789,764
Short transactions 6,228,732
Written options 602,637
Foreign currencies 564,236
Forward contracts 5,779,259
------------
46,964,628
------------
Increase in deposit at brokers for short sales (130,553)
Net investment income (24,177)
Net change in receivables /
payables related to operations 71,022
------------
(5,317,480)
----------
Net increase in cash 83,119
Cash, beginning of year 920
----------
Cash, end of year $ 84,039
----------
----------
Supplemental Information:
Cash paid for interest on loan outstanding $ 11,286
See notes to the financial statements.
THE MERGER FUND VL
STATEMENT OF CHANGES IN NET ASSETS
PERIOD MAY 26, 2004(1)<F17>
YEAR ENDED THROUGH
DECEMBER 31, 2005 DECEMBER 31, 2004
----------------- -----------------
Net investment loss $ (24,177) $ (2,358)
Net realized gain on investments sold,
short positions, written options expired or closed,
equity swap contracts, foreign currencies
and foreign currency exchange contracts 261,486 60,854
Change in unrealized appreciation / depreciation
on investments, short positions, written options,
equity swap contracts, foreign currency translation,
and forward currency exchange contracts (36,814) 19,265
---------- ----------
Net increase in net assets resulting from operations 200,495 77,761
---------- ----------
Distributions to shareholders from:
Net realized gains (60,590) --
---------- ----------
Total dividends distributions (60,590) --
---------- ----------
Net increase in net assets from
capital share transactions (Note 4) 4,072,524 1,183,772
---------- ----------
Net increase in net assets 4,212,429 1,261,533
NET ASSETS:
Beginning of period 1,361,533 100,000
---------- ----------
End of period (including accumulated undistributed
net investment income (loss)
of $(900) and $248, respectively) $5,573,962 $1,361,533
---------- ----------
---------- ----------
(1)<F17> Commencement of Operations.
See notes to the financial statements.
THE MERGER FUND VL
FINANCIAL HIGHLIGHTS
FOR THE PERIOD
MAY 26, 2004,(1)<F18>
YEAR ENDED THROUGH
DECEMBER 31, 2005 DECEMBER 31, 2004
----------------- -----------------
PER SHARE DATA:
Net Asset Value, beginning of period $10.60 $10.00
------ ------
Income from investment operations:
Net investment loss (0.05) (0.02)
Net realized and unrealized gain on investments 0.53 0.62
------ ------
Total from investment operations 0.48 0.60
------ ------
Less distributions:
Distributions from net realized gains (0.12) --
------ ------
Total distributions (0.12) --
------ ------
Net Asset Value, end of period $10.96 $10.60
------ ------
------ ------
Total Return 4.53% 6.00%(3)<F20>
Supplemental data and ratios:
Net assets, end of period (000's) $5,574 $1,362
Ratio of operating expenses to average net assets
including interest expense and dividends on short positions:
Before expense waiver 7.40% 43.30%(2)<F19>
After expense waiver 2.39% 1.62%(2)<F19>
Ratio of operating expenses to average net assets
excluding interest expense and dividends on short positions:
Before expense waiver 6.41% 43.08%(2)<F19>
After expense waiver 1.40% 1.40%(2)<F19>
Ratio of net investment loss to average net assets
Before expense waiver (5.58)% (42.14)%(2)<F19>
After expense waiver (0.57)% (0.46)%(2)<F19>
Portfolio turnover rate(4)<F21> 497.59% 501.71%(3)<F20>
(1)<F18> Commencement of Operations.
(2)<F19> Annualized.
(3)<F20> Not Annualized.
(4)<F21> The numerator for the portfolio turnover rate includes the lesser of
purchases or sales (excluding short positions). The denominator
includes the average long positions throughout the period.
See notes to the financial statements.
THE MERGER FUND VL
NOTES TO THE FINANCIAL STATEMENTS
DECEMBER 31, 2005
NOTE 1 -- ORGANIZATION
The Merger Fund VL (the "Fund") is a no-load, open-end, non-diversified
investment company organized as a statutory trust under the laws of Delaware on
November 22, 2002, and registered under the Investment Company Act of 1940, as
amended (the "1940 Act"). The Fund commenced operations on May 26, 2004. The
investment objective of the Fund is to seek to achieve capital growth by
engaging in merger arbitrage. Shares of the Fund are not offered directly to
the public. The Fund's shares are currently offered only to separate accounts
funding variable annuity and variable life insurance contracts. At December 31,
2005, 96.3% of the shares outstanding of the Fund were owned by one insurance
company.
NOTE 2 -- SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies followed by the
Fund in the preparation of its financial statements. These policies are in
conformity with generally accepted accounting principles.
A. Investment Valuation
Securities listed on the NASDAQ National Market are valued at the NASDAQ
Official Closing Price ("NOCP"). Other listed securities are valued at the last
sale price on the exchange on which such securities are primarily traded or, in
the case of options, at the higher of the intrinsic value of the option or the
last reported composite sale price. Securities not listed on an exchange are
valued at the last sale price as of the close of the New York Stock Exchange.
Securities for which there are no transactions are valued at the average of the
closing bid and asked prices. When pricing options, if no sales are reported or
if the last sale is outside the bid and asked parameters, the higher of the
intrinsic value of the option or the mean between the last reported bid and
asked prices will be used. Securities for which there are no such valuations
are valued at fair value as determined in good faith by management under the
supervision of the Board of Trustees. The Adviser (as defined herein), subject
to the supervision of the Board of Trustees, reserves the right to value
securities, including options, at prices other than last-sale prices, intrinsic
value prices, or the average of closing bid and asked prices, when such prices
are believed unrepresentative of fair market value as determined in good faith
by the Adviser. When fair-value pricing is employed, the prices of securities
used by the Fund to calculate its NAV may differ from quoted or published prices
for the same securities. In addition, due to the subjective and variable nature
of fair-value pricing, it is possible that the value determined for a particular
asset may be materially different from the value realized upon such asset's
sale. At December 31, 2005, fair-valued long securities represented 2.74% of
investments, at value. Investments in United States government securities
(other than short-term securities) are valued at the average of the quoted bid
and asked prices in the over-the-counter market. Short-term investments are
carried at amortized cost, which approximates market value.
B. Short Positions
The Fund may sell securities or currencies short for hedging purposes. For
financial statement purposes, an amount equal to the settlement amount is
included in the Statement of Assets and Liabilities as an asset and an
equivalent liability. The amount of the liability is subsequently marked-to-
market to reflect the current value of the short position. Subsequent
fluctuations in the market prices of securities or currencies sold, but not yet
purchased, may require purchasing the securities or currencies at prices which
may differ from the market value reflected on the Statement of Assets and
Liabilities.
The Fund is liable for any dividends payable on securities while those
securities are in a short position. As collateral for its short positions, the
Fund is required under the 1940 Act to maintain assets consisting of cash, cash
equivalents or liquid securities. These assets are required to be adjusted daily
to reflect changes in the value of the securities or currencies sold short.
C. Transactions with Brokers for Short Sales
The Fund's receivable from brokers for proceeds on securities sold short and
deposit at brokers for short sales are with two major securities dealers. The
Fund does not require the brokers to maintain collateral in support of the
receivable from the broker for proceeds on securities sold short.
D. Federal Income Taxes
No provision for federal income taxes has been made since the Fund has
complied to date with the provisions of the Internal Revenue Code applicable to
regulated investment companies and intends to continue to so comply in future
years and to distribute investment company net taxable income and net capital
gains to shareholders.
E. Written Options
The Fund writes (sells) call options to hedge portfolio investments. Put
options can also be written by the Fund as part of a merger arbitrage strategy
involving a pending corporate reorganization. When the Fund writes (sells) an
option, an amount equal to the premium received by the Fund is included in the
Statement of Assets and Liabilities as an asset and an equivalent liability. The
amount of the liability is subsequently marked-to-market to reflect the current
value of the option written. By writing an option, the Fund may become obligated
during the term of the option to deliver or purchase the securities underlying
the option at the exercise price if the option is exercised. Option contracts
are valued at the higher of the intrinsic value of the option or the last
composite sales price reported on the date of valuation. If no sale is reported
or if the last sale is outside the parameters of the closing bid and asked
prices, the option contract written is valued at the higher of the intrinsic
value of the option or the mean of the last reported bid and asked prices on the
day of valuation. When an option expires on its stipulated expiration date or
the Fund enters into a closing purchase transaction, the Fund realizes a gain or
loss if the cost of the closing purchase transaction differs from the premium
received when the option was sold without regard to any unrealized gain or loss
on the underlying security, and the liability related to such option is
eliminated. When an option is exercised, the premium originally received
decreases the cost basis of the security (or increases the proceeds on a sale of
the security), and the Fund realizes a gain or loss from the sale of the
underlying security.
F. Purchased Options
The Fund purchases put or call options to hedge portfolio investments.
Premiums paid for option contracts purchased are included in the Statement of
Assets and Liabilities as an asset. Option contracts are valued at the higher of
the intrinsic value of the option or the last composite sales price reported on
the date of valuation. If no sale is reported or if the last sale is outside the
parameters of the closing bid and asked prices, the option contract purchased is
valued at the higher of the intrinsic value of the option or the mean of the
last reported bid and asked prices on the day of valuation. When option
contracts expire or are closed, realized gains or losses are recognized without
regard to any unrealized gains or losses on the underlying securities.
G. Forward Currency Exchange Contracts
The Fund may enter into forward currency exchange contracts obligating the
Fund to deliver or receive a currency at a specified future date. Forward
contracts are valued daily, and unrealized appreciation or depreciation is
recorded daily as the difference between the contract exchange rate and the
closing forward rate applied to the face amount of the contract. A realized gain
or loss is recorded at the time the forward contract is closed.
H. Distributions to Shareholders
Dividends from net investment income and net realized capital gains, if any,
are declared and paid annually. Income and capital gain distributions are
determined in accordance with income tax regulations which may differ from
generally accepted accounting principles. These differences are due primarily to
wash loss deferrals, constructive sales, straddle loss deferrals, and unrealized
gains or losses on Section 1256 contracts, which were realized, for tax
purposes, at December 31, 2005. Accordingly, reclassifications are made within
the net asset accounts for such amounts, as well as amounts related to permanent
differences in the character of certain income and expense items for income tax
and financial reporting purposes. The Fund decreased net investment loss by
$23,029 and reduced realized accumulated gains by $23,029.
I. Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
J. Foreign Securities
Investing in securities of foreign companies and foreign governments involves
special risks and considerations not typically associated with investing in U.S.
companies and the U.S. government. These risks include revaluation of currencies
and adverse political and economic developments. Moreover, securities of many
foreign companies and foreign governments and their markets may be less liquid
and their prices more volatile than those of securities of comparable U.S.
companies and the U.S. government.
K. Foreign Currency Translations
The books and records of the Fund are maintained in U.S. dollars. Foreign
currency transactions are translated into U.S. dollars on the following basis:
(i) market value of investment securities, assets and liabilities at the daily
rates of exchange, and (ii) purchases and sales of investment securities,
dividend and interest income and certain expenses at the rates of exchange
prevailing on the respective dates of such transactions. For financial reporting
purposes, the Fund does not isolate changes in the exchange rate of investment
securities from the fluctuations arising from changes in the market prices of
securities. However, for federal income tax purposes, the Fund does isolate and
treat as ordinary income the effect of changes in foreign exchange rates on
realized gain or loss from the sale of investment securities and payables and
receivables arising from trade-date and settlement-date differences.
L. When-Issued Securities
The Fund may sell securities on a when-issued or delayed-delivery basis.
Although the payment and interest terms of these securities are established at
the time the Fund enters into the agreement, these securities may be delivered
for cash proceeds at a future date. The Fund records sales of when-issued
securities and reflects the values of such securities in determining net asset
value in the same manner as other open short-sale positions. The Fund segregates
and maintains at all times cash, cash equivalents or other liquid securities in
an amount at least equal to the market value for when-issued securities.
M. Guarantees and Indemnifications
In the normal course of business, the Fund enters into contracts with service
providers that contain general indemnification clauses. The Fund's maximum
exposure under these arrangements is unknown, as this would involve future
claims that may be made against the Fund that have not yet occurred. However,
based on experience, the Fund expects the risk of loss to be remote.
N. Other
Investment and shareholder transactions are recorded on the trade date.
Realized gains and losses from security transactions are recorded on the
identified cost basis. Dividend income and distributions to shareholders are
recorded on the ex-dividend date. Interest is accounted for on the accrual basis
and includes amortization of premiums and discounts on the interest method. The
Fund may utilize derivative instruments including options, forward currency
exchange contracts and other instruments with similar characteristics to the
extent that they are consistent with the Fund's investment objectives and
limitations. The use of these instruments may involve additional investment
risks, including the possibility of illiquid markets or imperfect correlation
between the value of the instruments and the underlying securities.
NOTE 3 -- AGREEMENTS
The Fund's investment adviser is Westchester Capital Management, Inc. (the
"Adviser") pursuant to an investment advisory agreement dated July 1, 2003.
Under the terms of this agreement, the Adviser is entitled to receive a fee,
calculated daily and payable monthly, at the annual rate of 1.25% of the Fund's
average daily net assets. Certain officers of the Fund are also officers of the
Adviser.
The Adviser has agreed to reduce its fees and reimburse the Fundto the extent
total annualized expenses, excluding dividends on short positions and interest
expense, exceed 1.40% of average daily net assets. The agreement expires on
July 1, 2013. The agreement permits the Adviser to recover the expenses paid in
excess of the cap on expenses for the three previous years, as long as the
recovery does not cause the Fund's operating expenses, excluding dividends on
short positions and interest expense, to exceed the cap on expenses. For the
year ended December 31, 2005, the Adviser reimbursed $213,775 to the Fund.
Reimbursed expenses subject to potential recovery by year of expiration is as
follows:
YEAR OF EXPIRATION POTENTIAL RECOVERY
------------------ ------------------
12/31/07 $214,818
12/31/08 $213,775
U.S. Bancorp Fund Services, LLC, a subsidiary of U.S. Bancorp, a publicly
held bank holding company, serves as transfer agent, administrator and
accounting services agent for the Fund. U.S. Bank, N.A. serves as custodian for
the Fund.
NOTE 4 -- SHARES OF BENEFICIAL INTEREST
The Trustees have the authority to issue an unlimited amount of shares of
beneficial interest without par value.
Changes in shares of beneficial interest were as follows:
YEAR ENDED PERIOD ENDED
DECEMBER 31, 2005 DECEMBER 31, 2004
-------------------- --------------------
SHARES AMOUNT SHARES AMOUNT
------ ------ ------ ------
Sold 408,699 $4,386,248 119,198 $1,191,029
Reinvested 5,533 60,590 -- --
Redeemed (34,317) (374,314) (713) (7,257)
------- ---------- ------- ----------
Net Increase 379,915 $4,072,524 118,485 $1,183,772
------- ---------- ------- ----------
------- ---------- ------- ----------
NOTE 5 -- INVESTMENT TRANSACTIONS
Purchases and sales of securities for the year ended December 31, 2005
(excluding short-term investments, options and short positions) amounted to
$27,561,221 and $21,246,207, respectively. There were no purchases or sales of
U.S. Government Securities.
At December 31, 2005, the components of accumulated earnings on a tax basis
were as follows:
Cost of investments $7,022,872
----------
----------
Gross unrealized appreciation $ 146,846
Gross unrealized depreciation (227,301)
----------
Net unrealized depreciation $ (80,455)
----------
----------
Undistributed ordinary income $ 361,380
Undistributed long-term capital gains --
----------
Total distributable earnings $ 361,380
----------
----------
Other accumulated losses and temporary differences $ (63,259)
----------
Total accumulated earnings $ 217,666
----------
----------
The tax components of dividends paid during the years ended December 31, 2005
and December 31, 2004 were as follows:
2005 2004
---- ----
Ordinary Income $60,590 $ --
Long-Term Capital Gains -- --
The Merger Fund VL had a post-October currency loss deferral of $141 and a
capital loss of $26,336, which is deferred for tax purposes until the next
fiscal year.
For corporate shareholders, the percent of ordinary income distributions
qualifying for the corporate dividends-received deduction for the fiscal year
ended December 31, 2005 was 1% for the Fund (unaudited).
NOTE 6 -- OPTION CONTRACTS WRITTEN
The premium amount and the number of option contracts written during the year
ended December 31, 2005, were as follows:
PREMIUM NUMBER OF
AMOUNT CONTRACTS
------- ---------
Options outstanding at December 31, 2004 $ 17,132 70
Options written 430,037 2,190
Options closed (131,272) (701)
Options exercised (174,685) (836)
Options expired (81,055) (493)
--------- -----
Options outstanding at December 31, 2005 $ 60,157 230
--------- -----
--------- -----
NOTE 7 -- CREDIT FACILITY
Custodial Trust Company has made available to the Fund a credit facility
under the 1940 Act limitation pursuant to a Loan and Security Agreement
("Agreement") dated August 16, 2004 for the purpose of purchasing portfolio
securities. The Agreement can be terminated by either the Fund or Custodial
Trust Company with three months' prior notice. For the period January 1, 2005
to December 31, 2005, the interest rate on the outstanding principal amount was
the 30 Day Libor Rate plus 0.75% (weighted average rate of 4.74% during the year
ended December 31, 2005). Advances are collateralized by securities owned by
the Fund and held separately in a special custody account pursuant to a Special
Custody Agreement dated July 1, 2003. During the year ended December 31, 2005,
the Fund had an outstanding average daily balance of $472,404. The maximum
amount outstanding during the year ended December 31, 2005 was $2,683,500. At
December 31, 2005, the Fund had a loan payable balance of $1,388,000. As
collateral for the loan, the Fund is required under the 1940 Act to maintain
assets consisting of cash, cash equivalents or liquid securities. The assets
are required to be adjusted daily to reflect changes in the amount of the loan
outstanding.
NOTE 8 -- FORWARD CURRENCY EXCHANGE CONTRACTS
At December 31, 2005, the Fund had entered into "position hedge" forward
currency exchange contracts that obligated the Fund to deliver or receive
currencies at a specified future date. The net unrealized depreciation of $58 is
included in the net unrealized appreciation (depreciation) section of the
accompanying financial statements. The terms of the open contracts are as
follows:
SETTLEMENT CURRENCY TO U.S. $ VALUE AT CURRENCY TO U.S. $ VALUE AT
DATE BE DELIVERED DECEMBER 31, 2005 BE RECEIVED DECEMBER 31, 2005
---------- ------------ ----------------- ----------- -----------------
1/31/06 156,200 British Pounds $268,639 U.S. Dollars $271,416
2/3/06 48,540 Canadian Dollars 41,811 U.S. Dollars 41,860
2/10/06 181,200 Canadian Dollars 156,111 U.S. Dollars 155,403
1/31/06 687,600 Danish Krone 109,331 U.S. Dollars 108,514
2/10/06 562,650 Swedish Krona 71,100 U.S. Dollars 69,741
-------- --------
$646,992 $646,934
-------- --------
-------- --------
NOTE 9 -- EQUITY SWAP CONTRACTS
The Fund has entered into both long and short equity swap contracts with
multiple broker-dealers. A long equity swap contract entitles the Fund to
receive from the counterparty any appreciation and dividends paid on an
individual security, while obligating the Fund to pay the counterparty any
depreciation on the security as well as interest on the notional amount of the
contract at a rate equal to LIBOR plus 25 to 100 basis points. A short equity
swap contract obligates the Fund to pay the counterparty any appreciation and
dividends paid on an individual security, while entitling the Fund to receive
from the counterparty any depreciation on the security as well as interest on
the notional value of the contract at a rate equal to LIBOR less 25 to 100 basis
points.
The Fund may also enter into equity swap contracts whose value is determined
by the spread between a long equity position and a short equity position. This
type of swap contract obligates the Fund to pay the counterparty an amount tied
to any increase in the spread between the two securities over the term of the
contract. The Fund is also obligated to pay the counterparty any dividends paid
on the short equity holding as well as any net financing costs. This type of
swap contract entitles the Fund to receive from the counterparty any gains based
on a decrease in the spread as well as any dividends paid on the long equity
holding and any net interest income.
Fluctuations in the value of an open contract are recorded daily as a net
unrealized gain or loss. The Fund will realize a gain or loss upon termination
or reset of the contract. Either party, under certain conditions, may terminate
the contract prior to the contract's expiration date.
Credit risk may arise as a result of the failure of the counterparty to
comply with the terms of the contract. The Fund considers the creditworthiness
of each counterparty to a contract in evaluating potential credit risk. The
counterparty risk to the Fund is limited to the net unrealized gain, if any, on
the contract, along with dividends receivable on long equity contracts and
interest receivable on short equity contracts. Additionally, risk may arise from
unanticipated movements in interest rates or in the value of the underlying
securities. At December 31, 2005, the Fund had the following open equity swap
contracts:
UNREALIZED APPRECIATION
TERMINATION DATE SECURITY SHARES (DEPRECIATION)
---------------- -------- ------ --------------
2/2/06 O2 plc 78,100 $ (3,284)
1/30/06 Old Mutual plc (46,852) (14,554)
1/30/06 Skandia Forsakrings AB 34,100 8,324
6/30/06 Telsystems International Wireless Inc. 16,200 1,158
--------
$ (8,356)
--------
--------
For the year ended December 31, 2005, the Fund realized losses of $8,962 upon
the termination of equity swap contracts.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Trustees and Shareholders of
The Merger Fund VL:
In our opinion, the accompanying statement of assets and liabilities, including
the schedules of investments, of securities sold short, and of options written,
and the related statements of operations, of cash flows and of changes in net
assets and the financial highlights present fairly, in all material respects,
the financial position of The Merger Fund VL (the "Fund") at December 31, 2005,
the results of its operations and cash flows for the year then ended, and the
changes in its net assets and the financial highlights for the periods
presented, in conformity with accounting principles generally accepted in the
United States of America. These financial statements and financial highlights
(hereafter referred to as "financial statements") are the responsibility of the
Fund's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
financial statements in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits, which included confirmation
of securities at December 31, 2005 by correspondence with the custodian and
brokers, provide a reasonable basis for our opinion.
/s/PricewaterhouseCoopers LLP
February 24, 2006
INFORMATION ABOUT TRUSTEES AND OFFICERS
The business and affairs of the Fund are managed under the direction of the
Fund's Board of Trustees. Information pertaining to the Officers and Trustees of
the Fund is set forth below. The Statement of Additional Information includes
additional information about the Fund's Officers and Trustees and is available,
without charge, upon request by calling 1-800-343-8959.
TERM OF # OF PORTFOLIOS OTHER
POSITIONS(S) OFFICE AND IN FUND COMPLEX DIRECTORSHIPS
HELD WITH LENGTH OF PRINCIPAL OCCUPATION OVERSEEN BY HELD BY
NAME, ADDRESS AND AGE THE FUND TIME SERVED DURING PAST FIVE YEARS TRUSTEE**<F23> TRUSTEE
- --------------------- ------------ ----------- ---------------------- --------------- -------------
Frederick W. Green*<F22> President Indefinite; President of 2 None
Westchester Capital and since Westchester Capital
Management, Inc. Trustee inception Management, Inc.,
100 Summit Lake Drive the Fund's Adviser.
Valhalla, NY 10595
Age: 59
Bonnie L. Smith Vice One-year Vice President of N/A None
Westchester Capital President, term; since Westchester Capital
Management, Inc. Secretary inception Management, Inc.,
100 Summit Lake Drive and the Fund's Adviser.
Valhalla, NY 10595 Treasurer
Age: 58
James P. Logan, III Independent Indefinite; President of Logan, 2 None
Logan, Chace LLC Trustee since Chace LLC, an
420 Lexington Avenue inception executive search firm.
New York, NY 10170 Chairman of J.P.
Age: 69 Logan & Company.
Michael J. Downey Independent Indefinite; Managing Partner of 2 Chairman and
c/o Westchester Capital Trustee since Lexington Capital Director of The
Management, Inc. inception Investments. Asia Pacific Fund,
100 Summit Lake Drive Consultant and Inc; Director of the
Valhalla, NY 10595 independent financial AllianceBernstein
Age: 61 adviser since July core mutual fund
1993. group.
Roy D. Behren Chief One-year Analyst and Trader N/A N/A
Westchester Capital Compliance term; for Westchester
Management, Inc. Officer since Capital Management,
100 Summit Lake Drive inception Inc., the Fund's Adviser.
Valhalla, NY 10595
Age: 45
*<F22> Denotes a trustee who is an "interested person" (as that term is
defined in Section 2(a)(19) of the Investment Company Act of 1940, as
amended) of the Fund or of the Fund's Adviser.
**<F23> The Fund Complex consists of the Fund and The Merger Fund.
THE MERGER FUND VL
AVAILABILITY OF PROXY VOTING INFORMATION
Information regarding how the Fund generally votes proxies relating to portfolio
securities may be obtained without charge by calling the Fund's Transfer Agent
at 1-800-343-8959 or by visiting the SEC's website at www.sec.gov. Information
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regarding how the Fund voted proxies relating to portfolio securities during the
period ended June 30, 2005 is available on the SEC's website or by calling the
toll-free number listed above.
AVAILABILITY OF QUARTERLY PORTFOLIO SCHEDULE
The Fund files its complete schedule of portfolio holdings with the SEC for the
first and third quarters of each fiscal year on Form N-Q. The Fund's Forms N-Q
are available on the SEC's website at www.sec.gov and may be reviewed and copied
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at the SEC's Public Reference Room in Washington, DC. Information on the
operation of the Public Reference Room may be obtained by calling
1-800-SEC-0330.
INVESTMENT ADVISER
Westchester Capital Management, Inc.
100 Summit Lake Drive
Valhalla, NY 10595
(914) 741-5600
ADMINISTRATOR, TRANSFER AGENT, DIVIDEND PAYING
AGENT AND SHAREHOLDER SERVICING AGENT
U.S. Bancorp Fund Services, LLC
615 East Michigan Street
P.O. Box 701
Milwaukee, WI 53201-0701
(800) 343-8959
CUSTODIAN
U.S. Bank, N.A.
P.O. Box 701
Milwaukee, WI 53201-0701
(800) 343-8959
TRUSTEES
Frederick W. Green
Michael J. Downey
James P. Logan, III
EXECUTIVE OFFICERS
Frederick W. Green, President
Bonnie L. Smith, Vice President,
Treasurer and Secretary
Roy D. Behren, Chief Compliance Officer
COUNSEL
Fulbright & Jaworski L.L.P.
666 Fifth Avenue
New York, NY 10103
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
PricewaterhouseCoopers LLP
100 East Wisconsin Avenue
Milwaukee, WI 53202
ITEM 2. CODE OF ETHICS.
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The registrant has adopted a code of ethics that applies to the registrant's
principal executive officer and principal financial officer. The registrant has
not made any amendments to its code of ethics during the period covered by this
report. The registrant has not granted any waivers from any provisions of the
code of ethics during the period covered by this report. A copy of the
registrant's Code of Ethics is filed herewith.
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.
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The registrant's board of trustees has determined that the registrant has at
least one audit committee financial expert serving on its audit committee.
Michael J. Downey and James P. Logan, III are each an "audit committee financial
expert" and are considered to be "independent" as each term is defined in Item 3
of Form N-CSR.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
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The registrant has engaged its principal accountant to perform audit services
and tax services during the past two fiscal years. "Audit services" refer to
performing an audit of the registrant's annual financial statements or services
that are normally provided by the accountant in connection with statutory and
regulatory filings or engagements for those fiscal years. "Tax services" refer
to professional services rendered by the principal accountant for tax
compliance, tax advice, and tax planning. The following table details the
aggregate fees billed or expected to be billed for each of the last two fiscal
years for audit fees and tax fees by the principal accountant.
FYE 12/31/2005 FYE 12/31/2004
--------------- ---------------
Audit Fees $25,000 $16,000
Audit-Related Fees
Tax Fees $5,000 $2,000
All Other Fees
The audit committee has adopted pre-approval policies and procedures that
require the audit committee to pre-approve all audit and non-audit services of
the registrant, including services provided to any entity affiliated with the
registrant. The audit committee approved 100% of the tax services provided by
the registrant's principal accountant. All of the principal accountant's hours
spent on auditing the registrant's financial statements were attributed to work
performed by full-time permanent employees of the principal accountant.
There were no non-audit fees billed by the registrant's accountant for services
rendered to the registrant and to the registrant's investment adviser, and any
entity controlling, controlled by, or under common control with the investment
adviser that provides ongoing services to the registrant for each of the last
two fiscal years of the registrant.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
- ----------------------------------------------
Not applicable.
ITEM 6. SCHEDULE OF INVESTMENTS.
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Schedule of Investments is included as part of the report to shareholders filed
under Item 1 of this Form.
ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END
- -------------------------------------------------------------------------
MANAGEMENT INVESTMENT COMPANIES.
- ---------------------------------
Not applicable to open-end investment companies.
ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES.
- -------------------------------------------------------------------------
Not applicable to open-end investment companies.
ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT
- ---------------------------------------------------------------------------
COMPANY AND AFFILIATED PURCHASERS.
- ----------------------------------
Not applicable to open-end investment companies.
ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
- ------------------------------------------------------------
There have been no material changes to the procedures by which shareholders may
recommend nominees to the registrant's board of trustees.
ITEM 11. CONTROLS AND PROCEDURES.
- ---------------------------------
(a) The Registrant's President/Principal Executive Officer and
Treasurer/Principal Financial Officer have reviewed the Registrant's
disclosure controls and procedures (as defined in Rule 30a-3(c) under the
Investment Company Act of 1940, as amended (the "Act")) as of a date within
90 days of the filing of this report, as required by Rule 30a-3(b) under
the Act and Rules 13a-15(b) or 15d-15(b) under the Securities Exchange Act
of 1934. Based on their review, such officers have concluded that the
disclosure controls and procedures are effective in ensuring that
information required to be disclosed in this report is appropriately
recorded, processed, summarized and reported and made known to them by
others within the Registrant and by the Registrant's service provider.
(b) There were no changes in the Registrant's internal control over financial
reporting (as defined in Rule 30a-3(d) under the Act) that occurred during
the second fiscal quarter of the period covered by this report that has
materially affected, or is reasonably likely to materially affect, the
Registrant's internal control over financial reporting.
ITEM 12. EXHIBITS.
- -----------------
(a) (1) Any code of ethics or amendment thereto, that is the subject of the
disclosure required by Item 2, to the extent that the registrant intends to
satisfy the Item 2 requirements through filing of an exhibit. Filed
herewith.
(2) Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of
2002. Filed herewith.
(3) Any written solicitation to purchase securities under Rule 23c-1 under
the Act sent or given during the period covered by the report by or on
behalf of the registrant to 10 or more persons. Not applicable to open-end
investment companies.
(b) Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Furnished herewith.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
(Registrant) The Merger Fund VL
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By (Signature and Title) /s/ Frederick W. Green
-----------------------------
Frederick W. Green, President
Date 2/28/06
-------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By (Signature and Title) /s/ Frederick W. Green
-----------------------------
Frederick W. Green, President
Date 2/28/06
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By (Signature and Title) /s/ Bonnie L. Smith
--------------------------
Bonnie L. Smith, Treasurer
Date 2/28/06
-------------------------