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 811-3445
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THE MERGER FUND
---------------
(Exact name of registrant as specified in charter)
100 SUMMIT LAKE DRIVE
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VALHALLA, NEW YORK 10595
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(Address of principal executive offices) (Zip code)
FREDERICK W. GREEN
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THE MERGER FUND
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100 SUMMIT LAKE DRIVE
---------------------
VALHALLA, NEW YORK 10595
------------------------
(Name and address of agent for service)
1-800-343-8959
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Registrant's telephone number, including area code
Date of fiscal year end: SEPTEMBER 30
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Date of reporting period: MARCH 31, 2006
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ITEM 1. REPORT TO STOCKHOLDERS.
- ------------------------------
THE
MERGER
FUND(R)
SEMI-ANNUAL REPORT
MARCH 31, 2006
CHART 1
PORTFOLIO COMPOSITION
BY TYPE OF DEAL*<F1>
Friendly 90.3%
Hostile 9.7%
CHART 2
PORTFOLIO COMPOSITION
BY TYPE OF BUYER*<F1>
Strategic 82.7%
Financial 17.3%
CHART 3
PORTFOLIO COMPOSITION
BY DEAL TERMS*<F1>
Stock with Fixed Exchange Ratio 0.3%
Stock with Flexible Exchange Ratio 6.8%
Cash & Stock 16.7%
Cash 67.0%
Undetermined 9.2%
*<F1> Data as of March 31, 2006
CHART 4
PORTFOLIO COMPOSITION
BY SECTOR*<F2>
Consumer Services 16.9%
Basic Industries 16.3%
Healthcare 15.7%
Telecommunications 12.3%
Financial Services 10.6%
Media & Entertainment 7.3%
Business Services 6.8%
Technology 5.2%
Energy 3.7%
Transportation 2.0%
Consumer Durables 1.2%
Multi-sector 1.0%
Consumer Non-Durables 1.0%
CHART 5
PORTFOLIO COMPOSITION
BY REGION*<F2>
United States 72.9%
Europe 22.0%
Canada 5.1%
*<F2> Data as of March 31, 2006
CHART 6
MERGER ACTIVITY
1991 - 2006
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 $246.3650 $108.3242 $97.1393 $188.5744
2005 $209.7712 $225.6564 $131.2077 $217.8712
2006 $236.3138
Source: Securities Data Corp.
THE MERGER FUND
EXPENSE EXAMPLE
MARCH 31, 2006
As a shareholder of the Fund, you incur two types of costs: (1) redemption fees
and (2) ongoing costs, including management fees; distribution and/or service
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 10/01/05 - 3/31/06.
ACTUAL EXPENSES
The first line of the table below provides information about actual account
values and actual expenses. Although the Fund charges no sales load or
transaction fees, you will be assessed fees for outgoing wire transfers,
returned checks and stop-payment orders at prevailing rates charged by U.S.
Bancorp Fund Services, LLC, the Fund's transfer agent. If you request that a
redemption be made by wire transfer, a $15.00 fee will be charged by the Fund's
transfer agent. You will be charged a redemption fee equal to 2.00% of the net
amount of the redemption if you redeem your shares less than 30 calendar days
after you purchase them. IRA accounts will be charged a $15.00 annual
maintenance fee. 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, shareholder servicing 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 10/1/05 VALUE 3/31/06 PERIOD 10/1/05-3/31/06*<F7>
----------------- -------------- ---------------------------
Actual +<F3> (1)<F5> $1,000.00 $1,025.40 $11.72
Hypothetical ++<F4> (2)<F6> $1,000.00 $1,013.36 $11.65
+<F3> Excluding dividends on short positions and interest expense, your
actual cost of investment in the Fund would be $6.97.
++<F4> Excluding dividends on short positions and interest expense, your
hypothetical cost of investment in the Fund would be $6.94.
(1)<F5> Ending account values and expenses paid during period based on a 2.54%
return. This actual return is net of expenses.
(2)<F6> Ending account values and expenses paid during period based on a 5.00%
annual return before expenses.
*<F7> Expenses are equal to the Fund's annualized expense ratio of 2.32%,
multiplied by the average account value over the period, multiplied by
182/365 (to reflect the one-half year period).
THE MERGER FUND
SCHEDULE OF INVESTMENTS
MARCH 31, 2006
(UNAUDITED)
SHARES VALUE
------ -----
COMMON STOCKS -- 76.17%
APPAREL MANUFACTURING -- 0.73%
281,200 Jones Apparel Group, Inc. $ 9,946,044
--------------
APPAREL RETAILING -- 0.89%
200,200 Burlington Coat Factory Warehouse Corp. 9,099,090
131,107 J. Jill Group Inc. (a)<F8> 3,134,768
--------------
12,233,858
--------------
AUDIO & VIDEO EQUIPMENT -- 0.66%
897,005 IMAX Corporation (a)<F8> 9,104,601
--------------
AUTOMOTIVE PARTS & EQUIPMENT -- 0.88%
695,850 Titan International, Inc. 12,010,371
--------------
BANKING -- 0.05%
25,700 North Fork Bancorporation, Inc. 740,931
--------------
BIOMETRICS -- 0.21%
367,288 Identix Incorporated (a)<F8> 2,923,612
--------------
BROADCASTING -- 2.77%
1,087,100 Lin TV Corp -- Class A (a)<F8> 9,783,900
819,000 Univision Communications Inc. (a)<F8> (g)<F14> 28,230,930
--------------
38,014,830
--------------
BROKERAGE SERVICES -- 1.77%
4,773,944 Instinet Group Incorporated (a)<F8> 24,290,304
--------------
BUILDING PRODUCTS -- 3.63%
592,500 Lafarge North America, Inc. (g)<F14> 49,770,000
--------------
CHEMICALS -- 0.83%
587,800 Huntsman Corporation (a)<F8> 11,344,540
--------------
EDUCATION SERVICES -- 2.48%
816,500 Education Management
Corporation (a)<F8> (e)<F12> 33,966,400
--------------
FOOD RETAILING -- 3.25%
1,738,750 Albertson's, Inc. (e)<F12> 44,633,713
--------------
GAS DISTRIBUTION -- 1.18%
396,100 KeySpan Corporation (g)<F14> 16,188,607
--------------
HEALTHCARE INFORMATION SERVICES -- 0.99%
1,053,713 Emdeon Corporation (a)<F8> 11,380,100
54,400 WebMD Health Corp. (a)<F8> (e)<F12> 2,265,216
--------------
13,645,316
--------------
HOSPITALITY -- 3.14%
965,400 Fairmont Hotels & Resorts Inc. (e)<F12> 43,153,380
--------------
INFORMATION TECHNOLOGY -- 3.38%
850,200 Anteon International Corporation (a)<F8> 46,386,912
--------------
INTEGRATED GAS & ELECTRIC COMPANIES -- 1.67%
711,500 Endesa, S.A. 22,969,970
--------------
LOTTERY SERVICES -- 1.82%
735,300 GTECH Holdings Corporation (e)<F12> 25,036,965
--------------
MEDICAL DEVICES -- 3.97%
697,750 Guidant Corporation 54,466,365
--------------
METALS & MINING -- 0.06%
25,100 Falconbridge Limited 878,555
--------------
MULTI-INDUSTRY -- 0.76%
385,300 Tyco International Ltd. (g)<F14> 10,356,864
--------------
NEWSPAPER PUBLISHING -- 3.10%
671,900 Knight Ridder, Inc. (h)<F15> 42,470,799
--------------
OFFICE PRODUCTS -- 1.81%
788,139 Dictaphone Corporation (a)<F8> (d)<F11> 24,826,379
--------------
OIL & GAS EXPLORATION & PRODUCTION -- 4.97%
740,216 Burlington Resources, Inc. (h)<F15> 68,141,620
--------------
PHARMACEUTICALS -- 7.19%
1,110,761 Abgenix, Inc. (a)<F8> 24,992,122
1 Allergan, Inc. 90
863,900 Andrx Corp. (a)<F8> (g)<F14> 20,508,986
512,000 Schering AG (f)<F13> 53,230,180
--------------
98,731,378
--------------
POWER CONVERSION & COMMUNICATIONS PRODUCTS -- 0.38%
473,700 Artesyn Technologies, Inc. (a)<F8> 5,187,015
--------------
PUBLISHING & MARKET RESEARCH -- 2.43%
1,023,774 VNU NV 33,287,109
--------------
REAL ESTATE INVESTMENT TRUSTS -- 3.53%
1,073,400 Arden Realty, Inc. (f)<F13> 48,442,542
--------------
SATELLITE COMMUNICATIONS -- 2.15%
1,189,400 PanAmSat Holding Corp. (f)<F13> 29,520,908
--------------
SAVINGS & LOANS -- 2.50%
824,590 Independence Community Bank Corp. 34,368,911
--------------
SPECIALTY CHEMICALS -- 2.31%
799,700 Engelhard Corporation (g)<F14> 31,676,117
--------------
STEEL -- 1.42%
495,278 Arcelor 19,524,702
--------------
TELEPHONY -- 9.26%
1,708,800 Nextel Partners, Inc. _
Class A (a)<F8> (f)<F13> 48,393,216
593,236 Portugal Telecom, SGPS, S.A. 7,196,360
4,044,898 Price Communications
Corporation (a)<F8> (f)<F13> 71,554,246
--------------
127,143,822
--------------
TOTAL COMMON STOCKS
(Cost $1,026,035,598) 1,045,383,440
--------------
CONTRACTS (100 SHARES PER CONTRACT)
- -----------------------------------
PUT OPTIONS PURCHASED -- 0.25%
2,029 Boston Scientific Corp.
Expiration: April, 2006, Exercise Price: $22.50 81,160
4,000 SPDR Trust Series 1
Expiration: April, 2006, Exercise Price: $128.00 200,000
3,700 Verizon Communications
Expiration: July, 2006, Exercise Price: $40.00 2,331,000
2,000 iShares Lehman 7-10 Year Treasury Bond Fund
Expiration: June, 2006, Exercise Price: $85.00 740,000
--------------
TOTAL PURCHASED OPTIONS
(Cost $3,316,611) 3,352,160
--------------
PRINCIPAL AMOUNT
- ----------------
TAX ESCROW NOTES -- 0.11%
$ 2,244,534 NextWave Wireless LLC Secured Note 1,458,947
--------------
TOTAL TAX ESCROW NOTES
(Cost $1,234,493) 1,458,947
--------------
CONVERTIBLE BONDS -- 0.10%
Adelphia Communications Corporation
26,583,000 3.250%, 05/01/2021 (c)<F10> 664,575
27,725,000 6.000%, 02/15/2006 (c)<F10> 693,125
--------------
TOTAL CONVERTIBLE BONDS
(Cost $21,766,335) 1,357,700
--------------
CORPORATE BONDS -- 4.09%
Adelphia Communications Corporation
9,695,000 9.250%, 10/01/2002 (c)<F10> 5,720,050
10,032,000 9.375%, 11/15/2009 (c)<F10> 6,169,680
14,690,000 10.250%, 06/15/2011 (c)<F10> 9,328,150
15,000,000 Meristar Hospitality Corporation
9.125%, 01/15/2011 17,343,750
10,000,000 Brookstone Company Inc.
12.000%, 10/15/2012 (Acquired 09/23/2005,
Cost $9,883,300) (b)<F9> 9,300,000
10,200,000 Toys "R" Us, Inc.
7.875%, 04/15/2013 8,300,250
--------------
TOTAL CORPORATE BONDS
(Cost $63,487,538) 56,161,880
--------------
SHORT TERM INVESTMENTS -- 11.10%
US GOVERNMENT AGENCY ISSUES -- 8.37%
Federal Home Loan Bank
20,000,000 4.470%, 04/05/2006 19,990,222
25,000,000 4.560%, 04/06/2006 24,984,687
28,000,000 2.650%, 04/07/2006 27,978,345
Federal Home Loan Mortgage Corp.
20,000,000 4.508%, 04/04/2006 19,992,667
22,000,000 Federal Farm Credit Bank
4.470%, 04/03/2006 21,994,622
--------------
114,940,543
--------------
VARIABLE RATE DEMAND NOTES -- 2.73%
8,997,050 American Family Financial Services, Inc., 4.469% 8,997,051
25,803,019 U.S. Bank, 4.573% 25,803,019
2,605,486 Wisconsin Corporate Central Credit Union, 4.493% 2,605,485
--------------
37,405,555
--------------
TOTAL SHORT TERM INVESTMENTS
(Cost $152,346,098) 152,346,098
--------------
TOTAL INVESTMENTS
(Cost $1,268,186,673) $1,260,060,225
--------------
--------------
Percentages are stated as a percent of net assets.
(a)<F8> Non-income producing security.
(b)<F9> Restricted under Rule 144A of the Securities Act of 1933.
(c)<F10> Security in default.
(d)<F11> Fair-valued security.
(e)<F12> All or a portion of the shares have been committed as collateral for
open short options.
(f)<F13> All or a portion of the shares have been committed as collateral for
foreign currency contracts.
(g)<F14> All or a portion of the shares have been committed as collateral for
written option contracts.
(h)<F15> All or a portion of the shares have been committed as collateral for
equity swap contracts.
See notes to the financial statements.
THE MERGER FUND
SCHEDULE OF SECURITIES SOLD SHORT
MARCH 31, 2006
(UNAUDITED)
SHARES VALUE
------ -----
1,048,000 Adelphia Communications Corporation -- Class A $ 46,112
834,650 Boston Scientific Corp. 19,238,682
5,700 Capital One Financial Corporation 458,964
534,975 ConocoPhillips 33,783,671
13,100 Inco Limited 653,122
293,600 McClatchy Company -- Class A 14,342,360
396,200 Mittal Steel Company N.V. -- ADR 15,167,566
316,445 SUPERVALU, Inc. 9,752,835
1,097,260 Verizon Communications 37,372,676
176,230 Viisage Technology, Inc. 3,085,787
220,830 WebMD Health Corp. -- Class A 9,195,361
------------
TOTAL SECURITIES SOLD SHORT
(Proceeds $139,124,661) $143,097,136
------------
------------
ADR - American Depository Receipt
See notes to the financial statements.
THE MERGER FUND
SCHEDULE OF OPTIONS WRITTEN
MARCH 31, 2006
(UNAUDITED)
CONTRACTS (100 SHARES PER CONTRACT) VALUE
- ----------------------------------- -----
CALL OPTIONS
7,402 Andrx Corp. $ 296,080
Expiration: September, 2006, Exercise Price: $25.00
Engelhard Corp.
3,854 Expiration: April, 2006, Exercise Price: $40.00 105,985
1,035 Expiration: May, 2006, Exercise Price: $40.00 56,925
Huntsman Corp.
2,910 Expiration: April, 2006, Exercise Price: $20.00 65,475
1,563 Expiration: May, 2006, Exercise Price: $17.50 324,323
732 Expiration: May, 2006, Exercise Price: $20.00 43,920
2,812 Jones Apparel Group, Inc. 267,140
Expiration: April, 2006, Exercise Price: $35.00
700 KeySpan Corporation 63,000
Expiration: May, 2006, Exercise Price: $40.00
LaFarge North America, Inc.
1,367 Expiration: April, 2006, Exercise Price: $80.00 553,635
4,558 Expiration: May, 2006, Exercise Price: $80.00 2,142,260
Tyco International Ltd.
1,194 Expiration: April, 2006, Exercise Price: $25.00 244,770
1,582 Expiration: May, 2006, Exercise Price: $27.50 110,740
Univision Communications, Inc.
3,000 Expiration: April, 2006, Exercise Price: $30.00 1,380,000
1,293 Expiration: April, 2006, Exercise Price: $35.00 84,045
2,982 Expiration: May, 2006, Exercise Price: $35.00 342,929
----------
TOTAL OPTIONS WRITTEN
(Premiums received $5,715,658) $6,081,227
----------
----------
See notes to the financial statements.
THE MERGER FUND
STATEMENT OF ASSETS AND LIABILITIES
MARCH 31, 2006
(UNAUDITED)
ASSETS:
Investments, at value (Cost $1,268,186,673) $1,260,060,225
Cash 83,817,084
Deposit at brokers for short sales 62,153,500
Receivable from brokers for proceeds on securities sold short 126,931,130
Receivable for investments sold 26,294,900
Receivable for written options 305,025
Receivable for fund shares issued 3,976,068
Dividends and interest receivable 3,436,248
Prepaid expenses 141,432
--------------
Total Assets 1,567,115,612
--------------
LIABILITIES:
Securities sold short, at value (Proceeds of $139,124,661) $143,097,136
Options written, at value (Premiums received $5,715,658) 6,081,227
See accompanying schedule
Payable for forward currency exchange contracts 939,907
Payable for investment securities purchased 36,941,280
Payable for fund shares redeemed 3,692,225
Payable for equity swap contracts 1,945,870
Investment advisory fee payable 1,141,831
Distribution fees payable 420,402
Accrued expenses and other liabilities 481,511
------------
Total Liabilities 194,741,389
--------------
NET ASSETS $1,372,374,223
--------------
--------------
NET ASSETS Consist Of:
Accumulated undistributed net realized loss on investments
sold, foreign currency translation, forward currency exchange
contracts, securities sold short, equity swap contracts,
and written option contracts expired or closed $ (28,794,770)
Net unrealized appreciation (depreciation) on:
Investments $ (8,126,448)
Securities sold short (3,972,475)
Written option contracts (365,569)
Equity swap contracts (1,259,877)
Forward currency exchange contracts (939,907)
------------
Net unrealized depreciation (14,664,276)
Paid-in capital 1,415,833,269
--------------
Total Net Assets $1,372,374,223
--------------
--------------
NET ASSET VALUE, offering price and redemption price per share
($1,372,374,223 / 89,886,347 shares of beneficial interest outstanding) $15.27
------
------
See notes to the financial statements.
THE MERGER FUND
STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED MARCH 31, 2006
(UNAUDITED)
INVESTMENT INCOME:
Interest $ 9,118,590
Dividend income on long positions
(net of foreign withholding taxes of $72,156) 6,348,537
-----------
Total investment income 15,467,127
-----------
EXPENSES:
Investment advisory fee $ 6,634,157
Distribution fees 1,441,237
Transfer agent and shareholder servicing agent fees 101,766
Federal and state registration fees 35,464
Professional fees 127,544
Trustees' fees and expenses 24,871
Custody fees 167,530
Administration fee 296,264
Fund accounting expense 90,840
Reports to shareholders 139,698
Dividends on short positions (net of foreign withholding taxes of $5,731) 2,343,947
Interest 3,897,986
Other 96,166
-----------
Total expenses 15,397,470
-----------
NET INVESTMENT GAIN 69,657
-----------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Realized gain (loss) on:
Investments 9,141,239
Securities sold short 17,431
Written option contracts expired or closed 19,312,943
Equity swap contracts (188,656)
Foreign currency translation 690,929
Forward currency exchange contracts 933,976
-----------
Net realized gain 29,907,862
Change in unrealized appreciation / depreciation on:
Investments 1,642,382
Securities sold short 3,911,794
Written option contracts (6,098,486)
Equity swap contracts (679,021)
Foreign currency translation 603
Forward currency exchange contracts (1,385,027)
-----------
Net unrealized loss (2,607,755)
-----------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS 27,300,107
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $27,369,764
-----------
-----------
See notes to the financial statements.
THE MERGER FUND
STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED MARCH 31, 2006
(UNAUDITED)
CASH PROVIDED (USED) BY FINANCING ACTIVITIES:
Sales of capital shares $ 352,986,086
Repurchases of capital shares (490,192,893)
Net change in receivables / payables related
to capital share transactions 41,220
---------------
Cash provided by capital share transactions (137,165,587)
Cash provided by borrowings (334,063,651)
Cash repayment of borrowing --
Distributions paid in cash*<F16> (2,463,350)
---------------
$(473,692,588)
-------------
CASH PROVIDED (USED) BY OPERATIONS:
Purchases of investments (3,794,349,664)
Proceeds from sales of investments 4,343,684,543
---------------
549,334,879
---------------
Increase in deposit at brokers for short sales 6,680,000
Net investment income 69,657
Net change in receivables / payables related to operations 3,687,305
---------------
10,436,962
559,771,841
-------------
Net increase in cash 86,079,253
Cash, beginning of year (2,262,169)
-------------
Cash, end of year $ 83,817,084
-------------
-------------
*<F16> Non-cash financing activities include reinvestment of dividends of $ 68,036,847
Supplemental Information:
Cash paid for interest $ 4,364,911
See notes to the financial statements.
THE MERGER FUND
STATEMENTS OF CHANGES IN NET ASSETS
SIX MONTHS ENDED YEAR ENDED
MARCH 31, 2006 SEPTEMBER 30, 2005
---------------- ------------------
(UNAUDITED)
Net investment gain (loss) $ 69,657 $ (5,524,327)
Net realized gain on investments sold, foreign
currency translations, forward currency exchange
contracts, securities sold short, equity swap contracts,
and written option contracts expired or closed 29,907,862 84,396,754
Change in unrealized appreciation / depreciation on
investments, foreign currencies, forward currency
exchange contracts, securities sold short, equity swap
contracts and written options (2,607,755) 11,038,149
-------------- --------------
Net increase in net assets resulting from operations 27,369,764 89,910,576
-------------- --------------
Distributions to shareholders from:
Net investment income (743,486) (221,569)
Net realized gains (69,756,711) (21,282,185)
-------------- --------------
Total dividends and distributions (70,500,197) (21,503,754)
-------------- --------------
Net decrease in net assets from capital
share transactions (Note 4) (69,169,960) (265,013,374)
-------------- --------------
Net decrease in net assets (112,300,393) (196,606,552)
NET ASSETS:
Beginning of year 1,484,674,616 1,681,281,168
-------------- --------------
End of year (including accumulated undistributed net
investment loss of $0 and ($5,495,315), respectively) $1,372,374,223 $1,484,674,616
-------------- --------------
-------------- --------------
See notes to the financial statements.
THE MERGER FUND
FINANCIAL HIGHLIGHTS
Selected per share data is based on a share of beneficial interest outstanding
throughout each period.
SIX MONTHS YEAR YEAR YEAR YEAR YEAR
ENDED ENDED ENDED ENDED ENDED ENDED
MARCH 31, SEPT. 30, SEPT. 30, SEPT. 30, SEPT. 30, SEPT. 30,
2006 2005 2004 2003 2002 2001
----------- --------- --------- --------- --------- ---------
(UNAUDITED)
Net Asset Value, beginning of period $15.78 $15.10 $14.84 $13.46 $15.74 $16.90
Income from investment operations:
Net investment income (loss)(1)<F17> 0.00(2)(5) (0.06)(2) (0.08)(3) 0.05(2) 0.22(3) 0.31(3)
<F18><F21> <F18> <F19> <F18> <F19> <F19>
Net realized and unrealized
gain (loss) on investments 0.37 0.94 0.38 1.53 (1.44) 0.32
------ ------ ------ ------ ------ ------
Total from investment operations 0.37 0.88 0.30 1.58 (1.22) 0.63
------ ------ ------ ------ ------ ------
Redemption fees 0.00(5) 0.00(5) 0.00(5) -- -- --
<F21> <F21> <F21>
------ ------ ------ ------ ------ ------
Less distributions:
Dividends from net investment income (0.01) 0.00(5) (0.04) (0.20) (0.21) (0.14)
<F21>
Distributions from net realized gains (0.87) (0.20) -- -- (0.85) (1.65)
------ ------ ------ ------ ------ ------
Total distributions (0.88) (0.20) (0.04) (0.20) (1.06) (1.79)
------ ------ ------ ------ ------ ------
Net Asset Value, end of period $15.27 $15.78 $15.10 $14.84 $13.46 $15.74
------ ------ ------ ------ ------ ------
------ ------ ------ ------ ------ ------
Total Return 2.54%(6) 5.88% 1.99% 11.88% (8.39)% 3.86%
<F22>
Supplemental Data and Ratios:
Net assets, end of period (000's) $1,372,374 $1,484,675 $1,681,281 $1,149,990 $853,957 $982,893
Ratio of operating expenses
to average net assets 2.32%(7) 1.77% 1.87% 1.86% 1.60% 1.99%
<F23>
Ratio of interest expense and
dividends on short positions to
average net assets 0.94%(7) 0.41% 0.50% 0.49% 0.22% 0.65%
<F23>
Ratio of operating expense to
average net assets excluding
interest expense and dividends
on short positions 1.38%(7) 1.36% 1.37% 1.37% 1.38% 1.34%
<F23>
Ratio of net investment income
to average net assets 0.01%(7) (0.35)% (0.68)% 0.22% 1.31% 1.91%
<F23>
Portfolio turnover rate(4)<F20> 159.22% 312.04% 256.88% 309.18% 258.37% 383.74%
FOOTNOTES TO FINANCIAL HIGHLIGHTS ON FOLLOWING PAGE
(1)<F17> Net investment income before interest expense and dividends on short
positions for the six months ended March 31, 2006 and the years ended
September 30, 2005, 2004, 2003, 2002 and 2001, was $0.07, $0.01,
$0.00, $0.01, $0.16 and $0.27, respectively.
(2)<F18> Net investment income per share is calculated using ending balances
prior to consideration of adjustments for permanent book and tax
differences.
(3)<F19> Net investment income per share represents net investment income for
the respective period divided by the monthly average shares of
beneficial interest outstanding throughout each period.
(4)<F20> 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.
(5)<F21> Amount less than $0.005 per share.
(6)<F22> Not annualized.
(7)<F23> Annualized.
See notes to the financial statements.
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS
MARCH 31, 2006 (UNAUDITED)
NOTE 1 -- ORGANIZATION
The Merger Fund (the "Fund") is a no-load, open-end, non-diversified
investment company organized as a trust under the laws of the Commonwealth of
Massachusetts on April 12, 1982, and registered under the Investment Company Act
of 1940, as amended (the "1940 Act"). The Fund was formerly known as the Risk
Portfolio of The Ayco Fund. In January of 1989, the Fund's fundamental policies
were amended to permit the Fund to engage exclusively in merger arbitrage. At
the same time, Westchester Capital Management, Inc. became the Fund's investment
adviser, and the Fund began to do business as The Merger Fund. Merger arbitrage
is a highly specialized investment approach generally designed to profit from
the successful completion of proposed mergers, takeovers, tender offers,
leveraged buyouts, liquidations and other types of corporate reorganizations.
NOTE 2 -- SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies consistently
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
sales 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 sales price. Securities not listed on an exchange and
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) 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-valued 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 March 31, 2006 fair-valued long
securities represented 1.97% 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 three 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. Additionally, the Fund intends to make all required
distributions to avoid federal excise tax.
E. Written Option Accounting
The Fund writes (sells) covered call options to hedge portfolio investments.
Uncovered 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 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 between 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 Option Accounting
The Fund purchases put options to hedge portfolio investments. Call options
may be purchased only for the purpose of closing out previously written covered
call options. 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 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 between 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 and 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, adjustments on
equity swap contracts, and unrealized gains or losses on Section 1256 contracts,
which were realized, for tax purposes, at September 30, 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 accumulated net investment loss by $5,053,286, reduced realized
accumulated gains by $7,405,945, and increased paid-in capital by $2,352,659.
The Fund may utilize earnings and profits deemed distributed to shareholders on
redemption of shares as part of the dividends-paid deduction.
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 involves special risks and
considerations not typically associated with investing in U.S. companies. These
risks include revaluation of currencies and adverse political and economic
developments. Moreover, securities of many foreign companies and their markets
may be less liquid and their prices more volatile than those of securities of
comparable U.S. companies.
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. Investment income includes $6,630,000 of interest earned on receivables
from brokers for proceeds on securities sold short and deposits. The Fund may
utilize derivative instruments such as 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 January 31, 1989.
Under the terms of this agreement, the Adviser is entitled to receive a fee,
calculated daily and payable monthly, at the annual rate of 1.00% of the Fund's
average daily net assets. Effective August 1, 2004, the Adviser agreed to waive
0.10% of its fee at net asset levels between $1.5 billion through $2 billion.
When net assets of the Fund exceed $2 billion, the Adviser has agreed to waive
0.20% of its fee. Certain officers of the Fund are also officers of the
Adviser.
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.
Distribution services are performed pursuant to distribution contracts with
broker-dealers and other qualified institutions.
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:
SIX MONTHS ENDED YEAR ENDED
MARCH 31, 2006 SEPTEMBER 30, 2005
------------------------- -------------------------
SHARES AMOUNT SHARES AMOUNT
--------- --------- --------- ---------
Sold 23,330,257 $ 352,986,086 20,234,535 $312,111,072
Issued as reinvestment
of dividends 4,637,846 68,036,847 1,355,022 20,840,244
Redemption fee -- 20,745 -- 44,851
Redeemed (32,191,665) (490,213,638) (38,803,235) (598,009,541)
----------- ------------- ----------- -------------
Net decrease (4,223,562) $ (69,169,960) (17,213,678) $(265,013,374)
----------- ------------- ----------- -------------
----------- ------------- ----------- -------------
NOTE 5 -- INVESTMENT TRANSACTIONS
Purchases and sales of securities for the six months ended March 31, 2006
(excluding short-term investments, options and short positions) aggregated
$2,226,202,194 and $2,789,510,775, respectively. There were no purchases or
sales of U.S. Government Securities.
At September 30, 2005, the components of accumulated losses on a tax basis
were as follows:
Cost of Investments $1,834,916,025
--------------
--------------
Gross unrealized appreciation 54,363,392
Gross unrealized depreciation (93,138,977)
--------------
Net unrealized depreciation $ (38,775,585)
--------------
--------------
Undistributed ordinary income $ 61,551,603
Undistributed long-term capital gain --
--------------
Total distributable earnings $ 61,551,603
--------------
--------------
Other accumulated losses (24,220,489)
--------------
Total accumulated losses $ (1,444,471)
--------------
--------------
The tax components of dividends paid during the six months ended March 31,
2006 and the fiscal year ended September 30, 2005 were as follows:
2006 2005
---- ----
Ordinary Income $70,500,197 $21,503,754
Long-Term Capital Gains $ -- $ --
The Fund incurred a post-October capital loss of $17,809,171, which is
deferred for tax purposes until the next fiscal year.
For the fiscal year ended September 30, 2005 certain dividends paid by the
Fund may be subject to a maximum tax rate of 15% as provided for by the Jobs and
Growth Tax Relief Reconciliation Act of 2003. The percentage of dividends
declared from net investment income designated as qualified dividend income was
24% for the Fund (unaudited).
For corporate shareholders, the percent of ordinary income distributions
qualifying for the corporate dividends-received deduction for the fiscal year
ended September 30, 2005 was 23% for the Fund (unaudited).
NOTE 6 -- OPTION CONTRACTS WRITTEN
The premium amount and the number of option contracts written during the six
months ended March 31, 2006, were as follows:
PREMIUM AMOUNT NUMBER OF CONTRACTS
-------------- -------------------
Options outstanding
at September 30, 2005 $ 23,611,205 109,602
Options written 42,252,658 222,417
Options closed (23,144,215) (79,800)
Options exercised (21,574,907) (90,799)
Options expired (15,429,083) (124,436)
------------ --------
Options outstanding at March 31, 2006 $ 5,715,658 36,984
------------ --------
------------ --------
NOTE 7 -- DISTRIBUTION PLAN
The Fund has adopted an Amended and Restated Plan of Distribution (the
"Plan") dated July 19, 2005, pursuant to Rule 12b-1 under the 1940 Act. Under
the Plan, the Fund will compensate broker-dealers or qualified institutions with
whom the Fund has entered into a contract to distribute Fund shares ("Dealers").
Under the Plan, the amount of such compensation paid in any one year shall not
exceed 0.25% annually of the average daily net assets of the Fund, which may be
payable as a service fee for providing recordkeeping, subaccounting, subtransfer
agency and/or shareholder liaison services. For the six months ended March 31,
2006, the Fund incurred $1,441,237 pursuant to the Plan.
The Plan will remain in effect from year to year provided such continuance
is approved at least annually by a vote either of a majority of the Trustees,
including a majority of the non-interested Trustees, or a majority of the Fund's
outstanding shares.
NOTE 8 -- CREDIT FACILITY
Custodial Trust Company has made available to the Fund a $400 million credit
facility (subject to increase under certain conditions) pursuant to a Loan and
Security Agreement ("Agreement") dated March 18, 1992 (subsequently amended) 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 October 1, 2005 to March 31, 2006, the interest rate on the
outstanding principal amount was the Federal Funds Rate plus 0.75% (weighted
average rate of 4.86% during the six months ended March 31, 2006). Advances are
collateralized by securities owned by the Fund and held separately in a special
custody account pursuant to a Special Custody Agreement dated March 31, 1994.
During the six months ended March 31, 2006, the Fund had an outstanding average
daily balance of $160,195,099. The maximum amount outstanding during the six
months ended March 31, 2006 was $355,058,000. At March 31, 2006, the Fund had a
loan-payable balance of $0. 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 9 -- FORWARD CURRENCY EXCHANGE CONTRACTS
At March 31, 2006, 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
$939,907 is included in the net unrealized appreciation (depreciation) section
of the Statement of Assets and Liabilities. 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 MARCH 31, 2006 BE RECEIVED MARCH 31, 2006
---------- ------------ --------------- ----------- ---------------
4/21/06 11,948,314 British Pounds $ 20,761,301 20,841,695 U.S. Dollars $ 20,841,696
4/24/06 5,250,000 British Pounds 9,122,514 9,081,975 U.S. Dollars 9,081,975
4/25/06 1,625,000 British Pounds 2,823,651 2,843,263 U.S. Dollars 2,843,263
4/28/06 34,289,007 British Pounds 59,582,651 59,971,840 U.S. Dollars 59,971,840
5/19/06 2,100,000 British Pounds 3,650,172 3,636,150 U.S. Dollars 3,636,150
4/13/06 188,250 Canadian Dollars 161,263 161,068 U.S. Dollars 161,068
6/16/06 415,448 Canadian Dollars 356,606 354,902 U.S. Dollars 354,902
4/25/06 37,884,000 Euros 45,973,157 45,562,535 U.S. Dollars 45,562,535
4/28/06 32,163,597 Euros 39,038,304 38,435,945 U.S. Dollars 38,435,945
5/19/06 25,498,650 Euros 30,989,908 30,673,643 U.S. Dollars 30,673,643
6/30/06 4,360,000 Euros 5,312,457 5,269,060 U.S. Dollars 5,269,060
------------ ------------
$217,771,984 $216,832,077
------------ ------------
------------ ------------
NOTE 10 -- 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 March 31, 2006, the Fund had the following open equity swap
contracts:
UNREALIZED APPRECIATION
TERMINATION DATE SECURITY SHARES (DEPRECIATION)
---------------- -------- ------ --------------
6/30/06-7/15/06 BAA PLC 1,413,331 $ 198,014
9/10/06 BOC Group PLC 2,143,063 (422,473)
5/19/06 London Stock Exchange 200,000 (466,064)
4/21/06 London Stock Exchange 500,000 (729,000)
4/21/06 London Stock Exchange April Call (500,000) 625,575
5/19/06 London Stock Exchange May Call (200,000) 346,884
7/15/06 McClatchy Company (50,000) 53,523
4/21/06 Prudential April Call (250,000) 25,050
4/21/06 Prudential PLC 250,000 (75,700)
4/1/06 Schering April Call (272,600) (352,382)
4/1/06 Schering April Call (189,400) (209,161)
6/30/06 Telesystem International Wireless Inc. 904,334 69,724
6/30/06 Telesystem International Wireless Inc. 310,000 (285,939)
6/30/06 Telesystem International Wireless Inc. 2,940,190 (37,928)
-----------
$(1,259,877)
-----------
-----------
For the six months ended March 31, 2006, the Fund realized losses of
$188,656 upon the termination of equity swap contracts. Such losses may have
been offset by gains on related long or short equity positions or forward
currency exchange contracts.
THE MERGER FUND
APPROVAL OF ADVISORY CONTRACT
On January 21, 2006, at a meeting called for the purpose of voting on such
approval, the Board of Trustees, including all of the Trustees who are not
parties to the Advisory Contract or interested persons of any such party (the
non-interested Trustees), approved the continuance of the Advisory Contract for
the Fund. In so doing, the Board studied materials specifically relating to the
Advisory Contract provided by the Adviser, counsel to the non-interested
Trustees and counsel to the Fund. The Board considered a variety of factors,
including the following:
The Board considered the nature, extent and quality of the services to be
provided by the Adviser to the Fund pursuant to the Advisory Contract, including
the Adviser's competence and integrity; research capabilities; implementation
and enforcement of compliance procedures and financial-reporting controls; and
adherence to the Fund's investment objectives, policies and restrictions. The
Board also reviewed the Adviser's methodology, research and analysis that it
employs in selecting investments for the Fund. The Board considered the non-
traditional nature of the Fund's investment approach, the specialized expertise
and experience of the Fund's portfolio managers and the difficulty, were it
warranted, of selecting an alternative adviser.
The Board also evaluated the investment performance of the Fund relative to
the S&P 500 Index over the last year, three years, five years and 10 years, and
relative to the performance of alternative-investment mutual funds, including
those that engage in merger arbitrage.
Additionally, the Board reviewed information on the fee structure of the
Advisory Contract, including the costs of the services to be provided and the
profits to be realized by the Adviser and its affiliate from their relationship
with the Fund, as evidenced by the Adviser's profitability analysis. The
profitability analysis consisted of income and expenses by category for calendar
years 2005 and 2004, less expenses allocated to other funds managed by the
Adviser's affiliate, adjusted total expenses, net income, profit margin and
profit margin before payments to fund supermarkets. The Board also reviewed
comparisons of the rates of compensation paid to managers of funds in its peer
group, Lipper data relating to average expenses and advisory fees for comparable
funds and the benefit to the Adviser of the Fund's soft-dollar arrangements. It
was noted that the Adviser's future profit margin is expected to decline
modestly as the Adviser absorbs additional expenses for hardware and financial
newswires. Based on the information provided, the Board determined that the
Fund's fee structure is competitive with funds with similar investment goals and
strategies.
The Board considered the Fund's total expense ratio, contractual investment
advisory fees, 12b-1 distribution expense and service-provider fee ratio
compared to the industry average by quartile, within the appropriate Lipper
benchmark category and Lipper category range. The Board also considered the
amount and nature of fees paid by shareholders. The Board considered the fact
that the Adviser has agreed to waive a portion of its fees and noted that the
fee waiver could be discontinued at any time after January 31, 2007.
The Adviser provided information on peer-group comparisons consisting of
alternative-investment mutual funds, including those that engage in merger
arbitrage. The materials compared each fund's investment strategies; management
fee; expense ratio; total assets; whether a fund has a breakpoint, charges a
sales load and is open to new investors; returns for the one year, three years,
five years and 10 years ended December 31, 2005; and risk as measured by beta
and standard deviation. It was noted that the Fund's management fees and
expense ratio are within the average range compared to its peer funds.
The Board considered the extent to which economies of scale would be
realized with respect to operational costs as the Fund grows in the number of
shareholders and assets under management, the existence of breakpoints
previously established by the Adviser, and whether fee levels to be charged by
the Adviser reflect these economies of scale for the benefit of Fund investors
and are fair under the circumstances, which the Board, including all of the non-
interested Trustees, believed to be the case.
Based on its evaluation, in consultation with independent counsel, of all
material aspects of the Advisory Contract, including the foregoing factors and
such other information believed to be reasonably necessary to evaluate the terms
of the Advisory Contract, the Board, including all of the non-interested
Trustees voting separately, concluded that the continuation of the Advisory
Contract would be in the best interest of the Fund's shareholders, and
determined that the compensation to the Adviser provided for in the Advisory
Contract is fair and reasonable.
THE MERGER FUND
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
-----------
regarding how the Fund voted proxies 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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Not applicable for semi-annual reports.
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.
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Not applicable for semi-annual reports.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
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Not applicable for semi-annual reports.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
- ----------------------------------------------
Not applicable to open-end investment companies.
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.
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Not applicable to open-end investment companies.
ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES.
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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 directors/trustees.
ITEM 11. CONTROLS AND PROCEDURES.
- ---------------------------------
(a) The Registrant's President/Chief Executive Officer and Treasurer/Chief
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 (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 significant 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.
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(a) (1) Any code of ethics or amendment thereto, that is subject of the
disclosure required by Item 2, to the extent that the registrant intends to
satisfy Item 2 requirements through filing an exhibit. Not Applicable.
(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
----------------------------------------
By (Signature and Title) /s/ Frederick W. Green
-----------------------------
Frederick W. Green, President
Date 5/30/06
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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 5/30/06
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By (Signature and Title) /s/ Bonnie L. Smith
-----------------------------
Bonnie L. Smith, Treasurer
Date 5/30/06
------------------------------------------------