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hours per response: 19.3
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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 811-09815
------------------------------------
The Arbitrage Funds
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in charter)
650 Fifth Avenue New York, New York 10019
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip code)
John S. Orrico
Water Island Capital, LLC 650 Fifth Avenue New York, New York 10019
- --------------------------------------------------------------------------------
(Name and address of agent for service)
Registrant's telephone number, including area code: (212) 259-2655
----------------------
Date of fiscal year end: May 31, 2005
-----------------------------------
Date of reporting period: May 31, 2005
-----------------------------------
Form N-CSR is to be used by management investment companies to file reports with
the Commission not later than 10 days after the transmission to stockholders of
any report that is required to be transmitted to stockholders under Rule 30e-1
under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may
use the information provided on Form N-CSR in its regulatory, disclosure review,
inspection, and policymaking roles.
A registrant is required to disclose the information specified by Form N-CSR,
and the Commission will make this information public. A registrant is not
required to respond to the collection of information contained in Form N-CSR
unless the Form displays a currently valid Office of Management and Budget
("OMB") control number. Please direct comments concerning the accuracy of the
information collection burden estimate and any suggestions for reducing the
burden to Secretary, Securities and Exchange Commission, 450 Fifth Street, NW,
Washington, DC 20549-0609. The OMB has reviewed this collection of information
under the clearance requirements of 44 U.S.C. ss. 3507.
ITEM 1. REPORTS TO STOCKHOLDERS.
[GRAPHIC OMITTED]
THE ARBITRAGE FUND
A SERIES OF THE ARBITRAGE FUNDS
650 Fifth Avenue
New York, New York 10019
ANNUAL REPORT
MAY 31, 2005
WWW.THEARBFUND.COM
[GRAPHIC OMITTED]
THE ARBITRAGE FUND
Water Island Capital, LLC
650 Fifth Avenue
New York, New York 10019
----
TEL: 212.259.2656 FAX: 212.259.2698
June 15, 2005
Dear Shareholder:
The Arbitrage Fund runs on a May 31 fiscal year. Accordingly, we are pleased to
enclose this year's Annual Report covering the period from June 1, 2004 through
May 31, 2005. As we have done in the past, we would like to take this
opportunity to review some of the key elements affecting the merger arbitrage
market today and share with you our outlook going forward.
Over the last 12 months, the merger arbitrage market has experienced a seismic
shift from limited dealflow in the US (or abroad for that matter) to what can
aptly be described as a global wave of dealflow following the conclusion of last
year's presidential election and the dramatic increase in economic activity in
places such as Australia and China.
SOMETHING OLD AND SOMETHING NEW
A wise man once observed "it's always darkest before the dawn" and the merger
market is no different. As new pent up dealflow overwhelmed the small stable of
existing transactions with thin spreads, arbitrage capital flowed out of those
thin pre-existing deals and into newer deals with better spreads. Better spreads
("profit margins") helped not just by increased deal volume but also in no small
measure by the rising short term interest rates on which spreads are based. The
result has been some dislocation in the market as spreads on old deals widened
as capital flowed out of the old and into the new. This reallocation of
arbitrage capital has resulted in a slight midyear reduction in the Fund's NAV.
We call this movement out of the old and into the new a dislocation and not a
decline for good reason. Far from being a negative or leading to an overall
decline, wider spreads fueled by the combined effect of stronger dealflow and
higher short term rates are a positive, creating excellent profit opportunities
for merger arbitrageurs, the sorts of which we have not seen since the last peak
in the merger cycle back in 1998-2000. While not easy to predict, and always
subject to the macro or geopolitical risks any portfolio is subject to, we
believe we are in the early stages of a return to such peak levels. In the
shorter term, we have experienced a little of that dark before the dawn.
Consequently, our portfolio holds a broad array of deals well diversified by
industry and geography. The portfolio is filled with wide spreads that we expect
will generate positive and competitive returns as they close over the weeks and
months ahead.
On behalf of the entire team here at Water Island, I would like to tell you that
we are committed to maximizing risk adjusted returns in every way prudently
possible. We strive to see the Fund's performance return to the levels of prior
years, and see the opportunity to do so.
1
When we look around at our peers in the arbitrage/hedge fund community
attempting to cope with the impact of increased interest expense on their
borrowed money and as we observe some of the public fund alternatives such as
high yield and REITs struggling to sustain their record highs, we feel very
comfortable with the prospects for our strategy on both an absolute and relative
basis.
We thank you for your commitment and, as always, we welcome your calls.
Sincerely,
/s/ John S. Orrico
John S. Orrico, CFA
Portfolio Manager
President, Water Island Capital, LLC
2
COMPARISON OF THE CHANGE IN VALUE OF A $10,000 INVESTMENT
IN THE ARBITRAGE FUND(A) VERSUS THE S&P 500 INDEX
[GRAPHIC OMITTED]
The Arbitrage Fund S&P 500 Index
------------------ -------------
09/17/00 10,000 09/17/00 10,000
11/30/00 -1.80% 9,820 11/30/00 -10.08% 8,992
02/28/01 28.88% 12,656 02/28/01 -5.43% 8,504
05/31/01 -7.61% 11,693 05/31/01 1.62% 8,641
08/31/01 -7.38% 10,831 08/31/01 -9.44% 7,826
11/30/01 -0.83% 10,740 11/30/01 0.86% 7,893
02/28/02 5.52% 11,333 02/28/02 -2.51% 7,695
05/31/02 2.29% 11,592 05/31/02 -3.25% 7,445
08/31/02 3.13% 11,955 08/31/02 -13.80% 6,417
11/30/2002 -0.26% 11,924 11/30/2002 2.68% 6,590
2/28/2003 3.89% 12,180 2/28/2003 -9.72% 5,949
5/31/2003 2.01% 12,799 5/31/2003 15.05% 6,845
8/31/2003 1.64% 13,008 8/31/2003 5.07% 7,192
11/30/2003 5.73% 13,753 11/30/2003 5.46% 7,584
2/29/2004 3.30% 14,207 2/29/2004 8.67% 8,241
5/31/2004 -3.91% 13,651 5/31/2004 -1.72% 8,099
8/31/2004 -3.75% 13,139 8/31/2004 -1.03% 8,016
11/30/2004 3.57% 13,608 11/30/2004 6.78% 8,559
2/28/2005 0.84% 13,722 2/28/2005 3.01% 8,816
5/31/2005 -1.57% 13,506 5/31/2005 -0.57% 8,766
AVERAGE ANNUAL TOTAL RETURNS(B)
(FOR PERIODS ENDED MAY 31, 2005)
1 YEAR SINCE INCEPTION
--------- -----------------
The Arbitrage Fund - Class R (1.07%) 6.60% (c)
The Arbitrage Fund - Class I (0.82%) 0.32% (d)
Standard & Poor's 500 Index 8.24% (2.76%)(c)
(a) The line graph above represents performance of Class R shares only,
which will vary from the performance of Class I shares based on the
difference in fees paid by shareholders in the different classes.
(b) The returns shown do not reflect the deduction of taxes a shareholder
would pay on Fund distributions or the redemption of Fund shares.
(c) Represents the period from the commencement of operations of Class R
shares (September 17, 2000) through May 31, 2005.
(d) Represents the period from the commencement of operations of Class I
shares (October 17, 2003) through May 31, 2005.
3
THE ARBITRAGE FUND
Portfolio Information
May 31, 2005 (Unaudited)
================================================================================
ASSET ALLOCATION (as a percentage of net assets)
- --------------------------------------------------------------------------------
Common Stocks - 93.75%
Real Estate Investment Trusts - 0.42%
[GRAPHIC OMITTED] Equity Swaps - 4.56%
Other - 1.27%
4
THE ARBITRAGE FUND
Statement of Assets and Liabilities
May 31, 2005
================================================================================
ASSETS
Investments in securities:
At acquisition cost $219,697,605
============
At value (Note 1) $228,111,421
Cash 31,726
Cash denominated in foreign currency (a) (Note 6) 215,823
Deposits with brokers for securities sold short (Note 1) 84,108,343
Dividends and interest receivable 356,412
Receivable for investment securities sold 7,590,451
Receivable for capital shares sold 107,002
Net unrealized appreciation on forward foreign currency 1,175,034
exchange contracts (Note 9)
Other assets 49,991
------------
Total Assets 321,746,203
------------
LIABILITIES
Written options, at value (Notes 1 and 4) (premiums
received $463,871) 608,602
Securities sold short, at value (Note 1) (proceeds
$78,769,029) 82,130,279
Payable for investment securities purchased 9,621,945
Payable for capital shares redeemed 461,354
Dividends payable on securities sold short (Note 1) 59,429
Payable to Adviser (Note 3) 271,159
Payable to Administrator (Note 3) 34,500
Other accrued expenses and liabilities 107,114
------------
Total Liabilities 93,294,382
------------
NET ASSETS $228,451,821
============
NET ASSETS CONSIST OF:
Paid-in capital $237,861,823
Accumulated net realized losses on security transactions
and option contracts (15,485,917)
Net unrealized appreciation (depreciation) on:
Investments 8,413,816
Short positions (3,361,250)
Written option contracts (144,731)
Translation of assets in foreign currencies 1,168,080
------------
Net Assets $228,451,821
============
PRICING OF CLASS R SHARES
Net assets applicable to Class R shares $134,034,909
============
Shares of beneficial interest outstanding (unlimited number
of shares authorized, no par value) 11,282,381
============
Net asset value and offering price per share (b) $ 11.88
============
PRICING OF CLASS I SHARES
Net assets applicable to Class I shares $ 94,416,912
============
Shares of beneficial interest outstanding (unlimited number
of shares authorized, no par value) 7,914,256
============
Net asset value and offering price per share (b) $ 11.93
============
(a) The cost of cash denominated in foreign currency is $215,821.
(b) Redemption price varies based on length of time held (Note 1).
See accompanying notes to financial statements.
5
THE ARBITRAGE FUND
Statement of Operations
For the Year Ended May 31, 2005
================================================================================
INVESTMENT INCOME
Dividends $ 2,315,954
Interest 1,113,411
Other (Note 8) 1,358
------------
Total Income 3,430,723
------------
EXPENSES
Investment advisory fees (Note 3) 4,738,991
Dividend expense 937,396
Distribution expense, Class R (Note 3) 463,237
Administration fees (Note 3) 337,051
Custodian and bank service fees 150,008
Fund accounting fees (Note 3) 111,839
Transfer agent and shareholder services fees,
Class R (Note 3) 30,708
Transfer agent, account maintenance and shareholder
services fees, Class I (Note 3) 51,140
Registration and filing fees, Common 25,509
Registration and filing fees, Class R 27,288
Registration and filing fees, Class I 21,233
Professional fees 72,046
Insurance expense 55,651
Postage and supplies 54,337
Trustees' fees 43,008
Compliance service fees (Note 3) 20,000
Printing of shareholder reports 11,543
Other expenses 18,227
------------
Total Expenses 7,169,212
Fees waived by the Adviser (Note 3) (267,326)
Class R expenses reimbursed by the Adviser (Note 3) (57,996)
Class I expenses reimbursed by the Adviser (Note 3) (72,373)
------------
Net Expenses 6,771,517
------------
NET INVESTMENT LOSS (3,340,794)
------------
REALIZED AND UNREALIZED GAINS (LOSSES) ON INVESTMENTS
AND FOREIGN CURRENCIES (Note 6)
Net realized gains (losses) from:
Security transactions (2,877,488)
Option contracts 867,279
Foreign currency transactions (267,246)
Net change in unrealized appreciation/depreciation on:
Investments 2,933,375
Short positions (3,695,496)
Written option contracts 88,045
Foreign currency translation 1,168,107
------------
NET REALIZED AND UNREALIZED LOSSES ON INVESTMENTS
AND FOREIGN CURRENCIES (1,783,424)
------------
NET DECREASE IN NET ASSETS FROM OPERATIONS $ (5,124,218)
============
See accompanying notes to financial statements.
6
THE ARBITRAGE FUND
Statements of Changes in Net Assets
==================================================================================================
YEAR YEAR
ENDED ENDED
MAY 31, MAY 31,
2005 2004
- --------------------------------------------------------------------------------------------------
FROM OPERATIONS
Net investment loss $ (3,340,794) $ (4,566,037)
Net realized gains (losses) from:
Security transactions (2,877,488) 925,201
Option contracts 867,279 10,514,976
Foreign currency transactions (267,246) (35)
Net change in unrealized appreciation/depreciation on:
Investments 2,933,375 (8,800,978)
Short positions (3,695,496) 9,418,295
Written option contracts 88,045 503,950
Foreign currency translation 1,168,107 (27)
------------ -------------
Net increase (decrease) in net assets resulting from operations (5,124,218) 7,995,345
------------ -------------
FROM DISTRIBUTIONS TO SHAREHOLDERS
Distributions from net realized gains, Class R (7,254,491) (7,829,264)
Distributions from net realized gains, Class I (4,670,105) (2,300,609)
------------ -------------
Decrease in net assets from distributions to shareholders (11,924,596) (10,129,873)
------------ -------------
FROM CAPITAL SHARE TRANSACTIONS (NOTE 5)
CLASS R
Proceeds from shares sold 43,128,832 252,248,398
Shares issued in reinvestment of distributions 7,011,970 7,709,210
Proceeds from redemption fees collected (Note 1) 25,653 77,063
Payments for shares redeemed (145,366,395) (153,665,252)
------------ -------------
Net increase (decrease) in net assets from
Class R share transactions (95,199,940) 106,369,419
------------ -------------
CLASS I
Proceeds from shares sold 54,421,439 191,327,000
Shares issued in reinvestment of distributions 4,413,952 2,176,251
Proceeds from redemption fees collected (Note 1) 10,556 18,074
Payments for shares redeemed (126,968,574) (18,812,223)
------------ -------------
Net increase (decrease) in net assets from
Class I share transactions (68,122,627) 174,709,102
------------ -------------
TOTAL INCREASE (DECREASE) IN NET ASSETS (180,371,381) 278,943,993
NET ASSETS
Beginning of year 408,823,202 129,879,209
------------ -------------
End of year $228,451,821 $ 408,823,202
============ =============
Accumulated net investment loss $ -- $ --
============ =============
See accompanying notes to financial statements.
7
THE ARBITRAGE FUND - CLASS R
Financial Highlights
====================================================================================================================================
SELECTED PER SHARE DATA AND RATIOS FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD
- ------------------------------------------------------------------------------------------------------------------------------------
YEAR YEAR YEAR YEAR PERIOD
ENDED ENDED ENDED ENDED ENDED
MAY 31, MAY 31, MAY 31, MAY 31, MAY 31,
2005 2004 2003 2002 2001(a)
- ------------------------------------------------------------------------------------------------------------------------------------
Net asset value at beginning of period $ 12.52 $ 12.20 $ 11.19 $ 11.66 $ 10.00
----------- ----------- ----------- ----------- -----------
Income (loss) from investment operations:
Net investment income (loss) (0.19) (0.19) (0.04) (0.04) 0.22
Net realized and unrealized gains (losses)
on investments and foreign currencies 0.07 1.01 1.20 (0.08) 1.46
----------- ----------- ----------- ----------- -----------
Total from investment operations (0.12) 0.82 1.16 (0.12) 1.68
----------- ----------- ----------- ----------- -----------
Less distributions:
From net investment income -- -- -- -- (0.02)
From net realized gains (0.52) (0.50) (0.15) (0.35)
----------- ----------- ----------- ----------- -----------
Total distributions (0.52) (0.50) (0.15) (0.35) (0.02)
----------- ----------- ----------- ----------- -----------
Proceeds from redemption fees collected 0.00(b) 0.00(b) -- -- --
----------- ----------- ----------- ----------- -----------
Net asset value at end of period $ 11.88 $ 12.52 $ 12.20 $ 11.19 $ 11.66
=========== =========== =========== =========== ===========
Total return (d) (1.07%) 6.66% 10.41% (0.86%) 16.93%(c)
=========== =========== =========== =========== ===========
Net assets at end of period (000's) $ 134,035 $ 239,494 $ 129,879 $ 11,314 $ 1,631
=========== =========== =========== =========== ===========
Ratio of gross expenses to average
net assets 2.36% 2.46% 3.00% 6.19% 51.30%(e)
Ratio of gross expenses to average net
assets excluding dividend expense (f) 2.06% 2.01% 2.54% 5.94% --
Ratio of net expenses to average net assets
excluding dividend expense (f) (g) 1.95% 1.95% 1.95% 1.94% 1.95%(e)
Ratio of net investment loss to
average net assets:
Before advisory fees waived and
expenses reimbursed (1.27%) (1.76%) (1.56%) (5.19%) (50.05%)(e)
After advisory fees waived and
expenses reimbursed (1.16%) (1.69%) (0.97%) (1.18%) (0.70%)(e)
Portfolio turnover rate 387% 251% 511% 2,480% 2,952%
(a) Represents the period from the commencement of operations (September 17,
2000) through May 31, 2001.
(b) Amount rounds to less than $0.01 per share.
(c) Not annualized.
(d) Total return is a measure of the change in the value of an investment in
the Fund over the periods covered, which assumes any dividends or capital
gains distributions are reinvested in shares of the Fund. Returns shown do
not reflect the deduction of taxes a shareholder would pay on Fund
distributions or the redemption of Fund shares.
(e) Annualized.
(f) Dividend expense totaled 0.30%, 0.45%, 0.46% and 0.25% of average net
assets for the years ended May 31, 2005, 2004, 2003 and 2002, respectively.
(g) Ratios were determined based on net assets after advisory fees waived and
expenses reimbursed. See accompanying notes to financial statements.
8
THE ARBITRAGE FUND - CLASS I
Financial Highlights
==================================================================================================
YEAR YEAR
ENDED ENDED
MAY 31, MAY 31,
2005 2004(a)
- --------------------------------------------------------------------------------------------------
Net asset value at beginning of period $ 12.54 $ 12.86
------------ ------------
Income (loss) from investment operations:
Net investment loss (0.15) (0.07)
Net realized and unrealized gains on
investments and foreign currencies 0.06 0.25
------------ ------------
Total from investment operations (0.09) 0.18
------------ ------------
Less distributions:
From net realized gains (0.52) (0.50)
------------ ------------
Proceeds from redemption fees collected 0.00(b) 0.00(b)
------------ ------------
Net asset value at end of period $ 11.93 $ 12.54
============ ============
Total return (d) (0.82%) 1.35%(c)
============ ============
Net assets at end of period (000's) $ 94,417 $ 169,330
============ ============
Ratio of gross expenses to average net assets 2.14% 2.27%(e)
Ratio of gross expenses to average net assets
excluding dividend expense (f) 1.84% 1.82%(e)
Ratio of net expenses to average net assets excluding
dividend expense (f) (g) 1.70% 1.70%(e)
Ratio of net investment loss to average net assets:
Before advisory fees waived and expenses reimbursed (1.05%) (1.56%)(e)
After advisory fees waived and expenses reimbursed (0.91%) (1.44%)(e)
Portfolio turnover rate 387% 251%(e)
(a) Represents the period from the commencement of operations (October 17,
2003) through May 31, 2004.
(b) Amount rounds to less than $0.01 per share.
(c) Not annualized.
(d) Total return is a measure of the change in the value of an investment in
the Fund over the periods covered, which assumes any dividends or capital
gains distributions are reinvested in shares of the Fund. Returns shown do
not reflect the deduction of taxes a shareholder would pay on Fund
distributions or the redemption of Fund shares.
(e) Annualized.
(f) Dividend expense totaled 0.30% and 0.45%(e) of average net assets for the
periods ended May 31, 2005 and 2004, respectively.
(g) Ratios were determined based on net assets after advisory fees waived and
expenses reimbursed. See accompanying notes to financial statements.
9
THE ARBITRAGE FUND
Portfolio of Investments
May 31, 2005
- --------------------------------------------------------------------------------
SHARES COMMON STOCKS -- 93.75% VALUE
- --------------------------------------------------------------------------------
AEROSPACE/DEFENSE -- 2.12%
65,000 United Defense Industries, Inc. .................. $ 4,843,150
-----------
BANKS -- 1.49%
80,000 Hibernia Corp. - Class A (b) ..................... 2,572,000
25,749 Main Street Trust, Inc. .......................... 759,607
15 UFJ Holdings, Inc. ............................... 76,688
-----------
3,408,295
-----------
BEVERAGES -- 0.51%
36,700 Coca-Cola Amatil Ltd. ............................ 218,333
600,000 Kingway Brewery Holdings Ltd. .................... 204,388
229,748 Southcorp Ltd. (a) ............................... 741,729
-----------
1,164,450
-----------
BIOTECHNOLOGY -- 0.48%
170,000 Oragenics, Inc. (a) .............................. 374,000
21,000 Transkaryotic Therapies, Inc. (a) (c) ............ 713,790
-----------
1,087,790
-----------
CHEMICALS -- 5.96%
1,121,400 Acetex Corp. (a) ................................. 7,670,376
175,300 Great Lakes Chemical Corp. ....................... 5,942,670
-----------
13,613,046
-----------
COMMERCIAL SERVICES -- 0.05%
22,050 Transurban Group ................................. 121,486
-----------
COMPUTERS -- 4.23%
453,717 Creo, Inc. (a) ................................... 7,350,215
2,000 NEC Soft Ltd. .................................... 57,509
310,000 Nuance Communications, Inc. (a) .................. 1,460,100
51,100 PEC Solutions, Inc. (a) .......................... 792,561
-----------
9,660,385
-----------
COSMETICS/PERSONAL CARE -- 2.29%
90,000 Gillette Co. (The) (b) ........................... 4,746,600
24,900 Paltac Corp. ..................................... 486,333
-----------
5,232,933
-----------
DIVERSIFIED FINANCIALS -- 1.99%
60,000 Henderson Group Plc (a) .......................... 66,843
635,600 Instinet Group, Inc. (a) ......................... 3,355,968
1,866,956 Loring Ward International Ltd. (a) ............... 1,116,468
-----------
4,539,279
-----------
ELECTRIC -- 0.24%
10,000 Public Service Enterprise Group, Inc. ............ 555,000
-----------
10
THE ARBITRAGE FUND
Portfolio of Investments (Continued)
May 31, 2005
================================================================================
SHARES COMMON STOCKS -- 93.75% (Continued) VALUE
- --------------------------------------------------------------------------------
ELECTRONICS -- 0.00%
2 Vishay Intertechnology, Inc. (a) ................. $ 26
-----------
ENTERTAINMENT -- 2.46%
121,300 Argosy Gaming Co. (a) (b) ........................ 5,624,681
-----------
FOOD -- 1.65%
139,500 Foodland Associated Ltd. ......................... 2,796,301
200,000 National Foods Ltd. .............................. 966,000
-----------
3,762,301
-----------
HEALTHCARE SERVICES AND PRODUCTS -- 9.85%
171,201 Advanced Medical Optics, Inc. (a) ................ 6,610,066
450,500 Beverly Enterprises, Inc. (a) (b) ................ 5,572,685
20,206 Closure Medical Corp. (a) ........................ 544,956
105,000 Guidant Corp. (b) ................................ 7,758,450
10,000 INAMED Corp. (a) (c) ............................. 622,300
30,000 Renal Care Group, Inc. (a) ....................... 1,387,200
-----------
22,495,657
-----------
HOME FURNISHINGS -- 0.24%
37,000 Maytag Corp. (c) ................................. 539,830
-----------
INTERNET SERVICES -- 10.47%
155,000 Ask Jeeves, Inc. (a) ............................. 4,713,550
472,122 DoubleClick, Inc. (a) ............................ 3,885,564
837,750 Internet Capital Group, Inc. (a) ................. 4,858,950
236,300 Macromedia, Inc. (a) (b) ......................... 10,449,186
-----------
23,907,250
-----------
LEISURE TIME -- 0.15%
3,000 Carnival Corp. ................................... 158,700
8,205 Skis Rossignol SA ................................ 191,782
-----------
350,482
-----------
LODGING -- 2.83%
300,000 Caesars Entertainment, Inc. (a) .................. 6,465,000
-----------
MACHINERY -- 1.18%
5,000 Rheinmetall AG ................................... 254,667
61,400 Thomas Industries, Inc. .......................... 2,448,018
-----------
2,702,685
-----------
MEDIA -- 3.09%
774,625 UnitedGlobalCom, Inc. (a) ........................ 7,049,088
-----------
11
THE ARBITRAGE FUND
Portfolio of Investments (Continued)
May 31, 2005
================================================================================
SHARES COMMON STOCKS -- 93.75% (Continued) VALUE
- --------------------------------------------------------------------------------
METAL FABRICATED -- 1.49%
160,207 Metals USA, Inc. (a) (b) ......................... $ 3,391,582
-----------
MINING -- 0.13%
50,000 WMC Resources Ltd. ............................... 295,000
-----------
OFFICE AND BUSINESS EQUIPMENT -- 1.68%
3,021,387 Danka Business Systems, Plc - ADR (a) ............ 3,837,162
-----------
OIL AND GAS -- 5.02%
195,000 Magnum Hunter Resources, Inc. (a) ................ 3,014,700
145,083 Mission Resources Corp. (a) (b) .................. 1,025,737
1,842 Noble Energy, Inc. ............................... 136,990
40,000 Premcor, Inc. (b) ................................ 2,714,800
2,835 Tel Offshore Trust ............................... 20,610
80,000 Unocal Corp. (b) ................................. 4,559,200
-----------
11,472,037
-----------
PHARMACEUTICALS -- 7.88%
158,500 Accredo Health, Inc. (a) (b) ..................... 7,103,970
144,797 Bone Care International, Inc. (a) ................ 4,740,654
34,000 Daiichi Pharmaceutical Co., Ltd. ................. 769,752
147,700 Eon Labs, Inc. (a) (b) ........................... 4,525,528
80,907 Orphan Medical, Inc. (a) ......................... 860,851
-----------
18,000,755
-----------
PIPELINES -- 3.17%
167,800 Kaneb Services LLC ............................... 7,232,180
-----------
RETAIL -- 4.35%
38,629 Brookstone, Inc. (a) ............................. 777,988
20,000 Electronics Boutique Holdings Corp. (a) .......... 1,186,200
10,000 Ito-Yokado Co., Ltd. ............................. 342,380
200,000 May Department Stores Co. (b) .................... 7,632,000
-----------
9,938,568
-----------
SEMICONDUCTORS -- 4.67%
772,920 August Technology Corp. (a) (b) .................. 8,788,100
701,019 Mindspeed Technologies, Inc. (a) ................. 1,002,457
66,000 Mykrolis Corp. (a) (b) ........................... 890,340
-----------
10,680,897
-----------
12
THE ARBITRAGE FUND
Portfolio of Investments (Continued)
May 31, 2005
================================================================================
SHARES COMMON STOCKS -- 93.75% (Continued) VALUE
- --------------------------------------------------------------------------------
SOFTWARE -- 7.94%
319,082 Concord Communications, Inc. (a) ................. $ 5,398,867
1,100 NEC System Technologies Ltd. ..................... 41,540
1,162,799 Pinnacle Systems, Inc. (a) (b) ................... 6,872,142
535,549 Private Business, Inc. (a) ....................... 867,589
199,250 VERITAS Software Corp. (a) ....................... 4,955,348
-----------
18,135,486
-----------
TELECOMMUNICATIONS -- 5.00%
112,500 Nextel Communications, Inc. - Class A (a) (b) .... 3,395,250
145,000 Time Warner Telecom, Inc. - Class A (a) .......... 739,500
180,000 Western Wireless Corp. - Class A (a) (b) ......... 7,165,800
366,100 Wireless Matrix Corp. (a) ........................ 134,279
-----------
11,434,829
-----------
TRANSPORTATION -- 1.14%
50,000 Amadeus Global Travel Distribution SA ............ 451,919
50,820 Overnite Corp. (b) ............................... 2,165,948
-----------
2,617,867
-----------
TOTAL COMMON STOCKS (Cost $204,870,712) .......... $214,159,177
-----------
================================================================================
SHARES EQUITY SWAPS -- 4.56% (Note 10) VALUE
- --------------------------------------------------------------------------------
300,000 Allied Domecq Plc ................................ $ 3,789,094
50,000 British Vita Plc ................................. 325,326
40,000 Corin Group Plc .................................. 258,800
25,000 Cox Insurance Holdings Plc (a) ................... 42,420
50,000 Danka Business Systems Plc (a) ................... 15,054
25,000 East Surrey Holdings Plc ......................... 241,944
180,000 London Stock Exchange Plc ........................ 1,574,688
124,919 Mersey Docks & Harbour Co. ....................... 2,194,757
450,000 MFI Furniture Group Plc .......................... 877,561
75,000 Singer & Friedlander Group Plc ................... 426,478
100,000 Somerfield Plc ................................... 359,955
500,000 Woolworths Group Plc ............................. 321,225
-----------
TOTAL EQUITY SWAPS (Cost $11,169,464) ............ $10,427,302
-----------
================================================================================
SHARES REAL ESTATE INVESTMENT TRUSTS -- 0.42% VALUE
- --------------------------------------------------------------------------------
90,000 O&Y Properties Corp. (Cost $955,890) ............. $ 957,302
-----------
13
THE ARBITRAGE FUND
Portfolio of Investments (Continued)
May 31, 2005
================================================================================
SHARES WARRANTS -- 0.00% VALUE
- --------------------------------------------------------------------------------
170,000 Oragenics, Inc. (a) (Cost $ --) .................. $ --
-----------
================================================================================
SHARES ESCROWED RIGHTS -- 0.06% VALUE
- --------------------------------------------------------------------------------
35,300 Hoenig Group, Inc. - contingent payment rights (a) $ --
209,440 Information Resources, Inc. - contingent value
rights (a) 146,608
247,200 PetroCorp, Inc. - escrow shares (a) .............. --
-----------
TOTAL ESCROWED RIGHTS (Cost $253,706) ............ $ 146,608
-----------
================================================================================
CONTRACTS CALL OPTION CONTRACTS -- 0.00% VALUE
- --------------------------------------------------------------------------------
Medicis Pharmaceutical Corp. - Class A,
100 07/18/05 at $30 (Cost $12,050) ................... $ 8,750
-----------
================================================================================
CONTRACTS PUT OPTION CONTRACTS -- 0.04% VALUE
- --------------------------------------------------------------------------------
Inamed Corp.,
100 07/16/05 at $60 .................................. $ 12,000
Johnson & Johnson,
150 06/18/05 at $65 .................................. 2,250
Medco Health Solutions, Inc.,
350 06/18/05 at $50 .................................. 47,250
50 07/16/05 at $50 .................................. 10,500
Transkaryotic Therapies, Inc.,
500 06/18/05 at $30 .................................. 13,750
-----------
TOTAL PUT OPTION CONTRACTS (Cost $109,251) ....... $ 85,750
-----------
================================================================================
SHARES MONEY MARKET SECURITIES -- 1.02% VALUE
- --------------------------------------------------------------------------------
2,326,532 Dreyfus Treasury Prime Cash Management Fund
(Cost $2,326,532) ............................... $ 2,326,532
-----------
TOTAL INVESTMENTS AT VALUE -- 99.85%
(Cost $219,697,605) ............................ $228,111,421
-----------
OTHER ASSETS IN EXCESS OF LIABILITIES -- 0.15% ... 340,400
-----------
NET ASSETS -- 100.00% ............................ $228,451,821
===========
(a) Non-income producing security.
(b) All or a portion of the shares have been committed as collateral for open
short positions.
(c) Underlying security for a written/purchased call/put option.
ADR - American Depository Receipt
See accompanying notes to portfolio of investments.
14
THE ARBITRAGE FUND
Schedule of Securities Sold Short
May 31, 2005
================================================================================
SHARES COMMON STOCKS -- 35.77% VALUE
- --------------------------------------------------------------------------------
BANKS -- 0.03%
9 Mitsubishi Tokyo Financial Group, Inc. ........... $ 75,574
-----------
BEVERAGES -- 0.77%
36,700 Coca-Cola Amatil Ltd. ............................ 218,333
9,870 Pernod Ricard SA ................................. 1,529,467
-----------
1,747,800
-----------
CHEMICALS -- 2.61%
388,000 Crompton Corp. ................................... 5,955,800
-----------
COMMERCIAL SERVICES -- 0.05%
22,050 Transurban Group ................................. 121,486
-----------
COSMETICS/PERSONAL CARE -- 2.19%
90,450 Procter & Gamble Co. (The) ....................... 4,988,318
-----------
DIVERSIFIED FINANCIALS -- 0.60%
18,100 Capital One Financial Corp. ...................... 1,364,740
-----------
ELECTRIC -- 0.25%
12,250 Exelon Corp. ..................................... 573,913
-----------
ELECTRONICS -- 0.04%
18,000 NEC Corp. (a) .................................... 100,710
-----------
FOOD -- 0.63%
246,000 Metcash Ltd. ..................................... 699,118
60,000 Woolworths Ltd. .................................. 730,720
-----------
1,429,838
-----------
HEALTHCARE SERVICES AND PRODUCTS -- 4.89%
165,800 Advanced Medical Optics, Inc. (a) ................ 6,401,538
71,200 Johnson & Johnson (b) ............................ 4,777,520
-----------
11,179,058
-----------
INTERNET SERVICES -- 3.31%
191,028 IAC/InterActiveCorp (a) (b) ...................... 4,680,186
127,735 Symantec Corp. (a) (b) ........................... 2,888,088
-----------
7,568,274
-----------
LODGING -- 2.09%
66,600 Harrah's Entertainment, Inc. ..................... 4,782,546
-----------
MEDIA -- 1.95%
106,094 Liberty Media International, Inc. (a) ............ 4,446,400
-----------
15
THE ARBITRAGE FUND
Schedule of Securities Sold Short (Continued)
May 31, 2005
================================================================================
SHARES COMMON STOCKS -- 35.77% (Continued) VALUE
- --------------------------------------------------------------------------------
OIL AND GAS -- 2.19%
81,000 Cimarex Energy Co. (a) ........................... $ 3,048,030
66,833 Petrohawk Energy Corp. (a) ....................... 584,121
20,000 Valero Energy Corp. .............................. 1,372,400
-----------
5,004,551
-----------
PHARMACEUTICALS -- 1.56%
45,000 Medco Health Solutions, Inc. (a) (b) ............. 2,250,000
38,000 MEDICEO Holdings Co., Ltd. ....................... 511,603
39,500 Sankyo Co., Ltd. ................................. 811,807
-----------
3,573,410
-----------
RETAIL -- 2.19%
62,300 Federated Department Stores, Inc. ................ 4,202,135
15,700 GameStop Corp. - Class A (a) ..................... 457,812
12,000 Seven-Eleven Japan Co., Ltd. ..................... 341,823
-----------
5,001,770
-----------
SOFTWARE -- 6.48%
326,214 Adobe Systems, Inc. .............................. 10,784,635
54,530 Avid Technology, Inc. (a) (b) .................... 3,197,639
199,900 ScanSoft, Inc. (a) ............................... 811,594
-----------
14,793,868
-----------
TELECOMMUNICATIONS -- 3.94%
96,150 ALLTEL Corp. ..................................... 5,593,046
143,800 Sprint Corp. ..................................... 3,406,622
-----------
8,999,668
-----------
TRANSPORTATION -- 0.00%
68 Yellow Roadway Corp. (a) ......................... 3,585
-----------
TOTAL COMMON STOCKS (Proceeds $78,314,181)........ $81,711,309
-----------
================================================================================
SHARES PREFERRED STOCKS -- 0.11% VALUE
- --------------------------------------------------------------------------------
5,000 Rheinmetall AG (Proceeds $277,103) ............... $ 254,667
-----------
================================================================================
SHARES EQUITY SWAPS -- 0.07% (Note 10) VALUE
- --------------------------------------------------------------------------------
3,000 Carnival Plc (Proceeds $177,745) ................. $ 164,303
-----------
TOTAL SECURITIES SOLD SHORT -- 35.95%
(Proceeds $78,769,029) ......................... $82,130,279
===========
(a) Non-income producing security.
(b) Underlying security for a written/purchased call/put option.
See accompanying notes to portfolio of investments.
16
THE ARBITRAGE FUND
Schedule of Open Options Written
May 31, 2005
================================================================================
CONTRACTS WRITTEN CALL OPTIONS VALUE
- --------------------------------------------------------------------------------
Avid Technology, Inc.,
215 06/18/05 at $50 ................................ $ 189,200
250 06/18/05 at $55 ................................ 103,750
ChevronTexaco Corp.,
618 06/18/05 at $55 ................................ 66,435
IAC/InterActiveCorp,
63 06/18/05 at $22.5 .............................. 12,915
Inamed Corp.,
100 07/16/05 at $65 ................................ 11,000
Johnson & Johnson,
150 06/18/05 at $70 ................................ 1,500
Medco Health Solutions, Inc.,
100 06/18/05 at $55 ................................ 750
300 06/18/05 at $60 ................................ 750
200 07/16/05 at $55 ................................ 11,500
50 07/16/05 at $60 ................................ 500
Medicis Pharmaceutical Corp.,
50 07/16/05 at $25 ................................ 18,250
Maytag Corp.,
370 06/18/05 at $15 ................................ 9,250
Symantec Corp.,
559 06/18/05 at $20 ................................ 145,340
630 06/18/05 at $22.5 .............................. 34,650
Transkaryotic Therapies, Inc.,
75 06/18/05 at $35 ................................ 2,812
-----------
TOTAL WRITTEN CALL OPTIONS (Premiums Received
$463,871) ...................................... $ 608,602
-----------
TOTAL OPEN OPTIONS WRITTEN (Premiums Received
$463,871) ...................................... $ 608,602
===========
See accompanying notes to financial statements.
17
THE ARBITRAGE FUND
Notes to the Financial Statements
May 31, 2005
================================================================================
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
The Arbitrage Funds (the "Trust") was organized as a Delaware business trust on
December 22, 1999 and is registered under the Investment Company Act of 1940, as
amended (the "1940 Act"), as an open-end management investment company issuing
its shares in series, each series representing a distinct portfolio with its own
investment objective and policies. The one series presently authorized is The
Arbitrage Fund (the "Fund"), a diversified series, which offers two classes of
shares. Class R shares and Class I shares commenced operations on September 17,
2000 and October 17, 2003, respectively.
The investment objective of the Fund is to achieve capital growth by engaging in
merger arbitrage.
The Fund's two classes of shares, Class R and Class I, represent interests in
the same portfolio of investments and have the same rights, but differ primarily
in the expenses to which they are subject and the investment eligibility
requirements. Class R shares are subject to an annual distribution fee of up to
..25% of the Fund's average daily net assets allocable to Class R shares, whereas
Class I shares are not subject to any distribution fees.
The following is a summary of the Fund's significant accounting policies:
SECURITIES VALUATION - The Fund's portfolio securities are valued as of the
close of business of the regular session of the New York Stock Exchange ("NYSE")
(normally 4:00 p.m., Eastern time). Common stocks and other securities,
including open short positions, that are traded on a securities exchange are
valued at the last quoted sales price at the close of regular trading on the day
the valuation is made. Securities which are quoted by NASDAQ are valued at the
NASDAQ Official Closing Price. Price information on listed stocks is taken from
the exchange where the security is primarily traded. Securities which are listed
on an exchange but which are not traded on the valuation date are valued at the
mean of the most recent bid and asked prices. Securities traded in the
over-the-counter market, and which are not quoted by NASDAQ, are valued at the
mean of the most recent bid and asked prices. Put and call options and
securities traded in the over-the-counter market are valued at the mean of the
most recent bid and asked prices. Unlisted securities for which market
quotations are readily available are valued at the latest quoted bid price.
Other assets and securities for which no quotations are readily available are
valued at fair value as determined in good faith under the supervision of the
Board of Trustees of the Trust. Such methods of fair valuation may include, but
are not limited to: multiple of earnings, multiple of book value, discount from
market of a similar freely traded security, purchase price of a security,
subsequent private transactions in the security or related securities, or a
combination of these and other factors. Foreign securities are translated from
the local currency into U.S. dollars using currency exchange rates supplied by a
quotation service.
18
THE ARBITRAGE FUND
Notes to the Financial Statements (Continued)
May 31, 2005
================================================================================
REPURCHASE AGREEMENTS - The Fund may enter into repurchase agreements with
certain banks or non-bank dealers. The adviser to the Fund will monitor, on an
ongoing basis, the value of the underlying securities to ensure that the value
always equals or exceeds the repurchase price plus accrued interest.
SHARE VALUATION - The net asset value per share of each class of shares of the
Fund is calculated daily by dividing the total value of the Fund's assets
attributable to that class, less liabilities attributable to that class, by the
number of shares of that class outstanding. The offering price and redemption
price per share of each class of the Fund is equal to the net asset value per
share, except that, shares of each class are subject to a redemption fee of 2%
if redeemed within 90 days of the date of purchase. For the year ended May 31,
2005, proceeds from redemption fees were $25,653 in Class R and $10,556 in Class
I.
INVESTMENT INCOME - Interest income is accrued as earned. Dividend income is
recorded on the ex-dividend date.
DISTRIBUTIONS TO SHAREHOLDERS - Dividends arising from net investment income and
net capital gain distributions, if any, are declared and paid at least annually
to shareholders of the Fund. The amount of distributions from net investment
income and net realized gains are determined in accordance with federal income
tax regulations which may differ from accounting principles generally accepted
in the United States of America. These "book/tax" differences are either
temporary or permanent in nature and are primarily due to losses deferred due to
wash sales.
The tax character of distributions paid during the years ended May 31, 2005 and
May 31, 2004 was as follows:
- --------------------------------------------------------------------------------
Year Ordinary Long-Term Total
Ended Income Capital Gains Distributions
- --------------------------------------------------------------------------------
5/31/05 $ 10,778,315 $ 1,146,281 $ 11,924,596
5/31/04 $ 10,129,873 $ -- $ 10,129,873
- --------------------------------------------------------------------------------
ALLOCATION BETWEEN CLASSES - Investment income earned, realized capital gains
and losses, and unrealized appreciation and depreciation are allocated daily to
each class of shares based upon its proportionate shares of total net assets of
the Fund. Class specific expenses are charged directly to the class incurring
the expense. Common expenses which are not attributable to a specific class are
allocated daily to each class of shares based upon its proportionate share of
total net assets of the Fund.
SECURITY TRANSACTIONS - Security transactions are accounted for on trade date.
Gains and losses on securities sold are determined on a specific identification
basis.
SHORT POSITIONS - The Fund may sell securities short for economic 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
19
THE ARBITRAGE FUND
Notes to the Financial Statements (Continued)
May 31, 2005
================================================================================
the liability is subsequently marked-to-market to reflect the current value of
the short position. Subsequent fluctuations in the market prices of securities
sold, but not yet purchased, may require purchasing the securities 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. The amount of the collateral is required
to be adjusted daily to reflect changes in the value of the securities sold
short.
OPTION TRANSACTIONS - The Fund may write (sell) covered call options to hedge
portfolio investments. Put options may 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 average of the
current bid and asked price reported 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).
ESTIMATES - The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities at the date of the financial statements and
the reported amounts of income and expenses during the reporting period. Actual
results could differ from those estimates.
FEDERAL INCOME TAX - It is the Fund's policy to comply with the special
provisions of Subchapter M of the Internal Revenue Code applicable to regulated
investment companies. As provided therein, in any fiscal year in which a Fund so
qualifies and distributes at least 90% of its taxable net income, the Fund (but
not the shareholders) will be relieved of federal income tax on the income
distributed. Accordingly, no provision for income taxes has been made.
In order to avoid imposition of the excise tax applicable to regulated
investment companies, it is also the Fund's intention to declare as dividends in
each calendar year at least 98% of its net investment income (earned during the
calendar year) and 98% of its net realized capital gains (earned during the
twelve months ended October 31) plus undistributed amounts from prior years.
20
THE ARBITRAGE FUND
Notes to the Financial Statements (Continued)
May 31, 2005
================================================================================
The following information is computed on a tax basis for each item as of May 31,
2005:
- --------------------------------------------------------------------------------
Cost of portfolio investments (including securities
sold short and written options) $ 154,448,818
=============
Gross unrealized appreciation $ 11,070,303
Gross unrealized depreciation (20,146,581)
-------------
Net unrealized depreciation (9,076,278)
Net unrealized appreciation on translation of assets
and liabilities in foreign currencies 1,168,080
Capital loss carryforward (1,501,804)
-------------
Total accumulated deficit $ (9,410,002)
=============
- --------------------------------------------------------------------------------
The difference between the federal income tax cost of portfolio investments and
the financial statement cost is due to the tax deferral of losses on wash sales.
As of May 31, 2005, the Fund had a capital loss carryforward of $1,501,804,
which expires May 31, 2013. The capital loss carryforward may be utilized in
future years to offset net realized capital gains, if any, prior to distributing
such gains to shareholders.
For the year ended May 31, 2005, the Fund reclassified net investment losses of
$3,340,794 and losses on foreign currency transactions of $267,246 against
paid-in capital on the Statement of Assets and Liabilities. Such
reclassification, the result of permanent differences between financial
statement and income tax reporting requirements, has no effect on the Fund's net
assets or net asset value per share.
2. INVESTMENT TRANSACTIONS
During the year ended May 31, 2005, cost of purchases and proceeds from sales
and maturities of investment securities, other than short-term investments, U.S.
government securities, options and short positions, amounted to $1,189,901,427
and $1,200,277,977, respectively.
3. TRANSACTIONS WITH AFFILIATES
INVESTMENT ADVISORY AGREEMENT
The Fund's investments are managed by Water Island Capital, LLC (the "Adviser")
under the terms of an Investment Advisory Agreement. Under the Investment
Advisory Agreement, the Fund pays the Adviser a fee, which is computed and
accrued daily and paid monthly, at the annual rate of 1.50% of the Fund's
average daily net assets.
Until August 31, 2012, the Adviser has contractually agreed to waive its
advisory fee and/or reimburse the Fund's other expenses to the extent that total
operating expenses (exclusive of interest, taxes, dividends on short positions,
brokerage commissions and other costs incurred in connection with the purchase
or sale of portfolio securities) exceed the annual rate of 1.95% of the Fund's
average daily net assets allocable to Class R shares and 1.70% of the Fund's
average daily net assets allocable to Class I shares. Accordingly, for the year
ended May 31, 2005, the Adviser waived $267,326 of its advisory fee and
reimbursed the Fund for $57,996 and $72,373 of Class R and Class I expenses,
respectively.
21
THE ARBITRAGE FUND
Notes to the Financial Statements (Continued)
May 31, 2005
================================================================================
The Adviser is permitted to recoup fees waived or expenses reimbursed after May
31, 2004 to the extent actual fees and expenses for a period are less than the
expense limitation cap of each class, provided, however, that the Adviser shall
only be entitled to recoup such amounts for a period of three years from the end
of the fiscal year during which such amount was waived or reimbursed.
Certain officers of the Trust are also officers of the Adviser. Effective
October 1, 2004, the Vice President of the Trust also serves as Chief Compliance
Officer ("CCO") of the Trust and of the Adviser. The Fund pays the Adviser
$30,000 annually for providing CCO services.
ADMINISTRATION AGREEMENT
Under the terms of an Administration Agreement, Ultimus Fund Solutions, LLC
("Ultimus") supplies executive, administrative and regulatory services to the
Fund, supervises the preparation of tax returns, and coordinates the preparation
of reports to shareholders and reports to and filings with the Securities and
Exchange Commission and state securities authorities. For the performance of
these administrative services, Ultimus receives a monthly fee at an annual rate
of .15% of the Fund's average daily net assets up to $50 million; .125% of such
assets from $50 million to $100 million; .10% of such assets from $100 million
to $250 million; .075% of such assets from $250 to $500 million; and .05% of
such assets in excess of $500 million, subject to a minimum fee of $2,000 per
month. For the year ended May 31, 2005, Ultimus was paid $337,051 under the
administration agreement. Certain officers of the Trust are also officers of
Ultimus.
TRANSFER AGENT AND SHAREHOLDER SERVICES AGREEMENT
Under the terms of a Transfer Agent and Shareholder Services Agreement between
the Trust and Ultimus, Ultimus maintains the records of each shareholder's
account, answers shareholders' inquiries concerning their accounts, processes
purchases and redemptions of Fund shares, acts as dividend and distribution
disbursing agent and performs other shareholder service functions. For these
services, Ultimus receives from the Fund a monthly fee at an annual rate of $20
per account, subject to a minimum fee of $1,500 per month for each class of
shares. For the year ended May 31, 2005, Ultimus was paid $48,708 under the
transfer agent agreement. In addition, the Fund pays out-of-pocket expenses
including, but not limited to, postage and supplies.
For shareholder accounts held through financial intermediaries, Class I may, in
some cases, compensate these intermediaries for providing account maintenance
services to their customers at an annual rate of not more than $20 per account.
For the year ended May 31, 2005, Class I paid $33,140 to financial
intermediaries for account maintenance services.
22
THE ARBITRAGE FUND
Notes to the Financial Statements (Continued)
May 31, 2005
================================================================================
FUND ACCOUNTING AGREEMENT
Under the terms of a Fund Accounting Agreement between the Trust and Ultimus,
Ultimus calculates the daily net asset value per share and maintains the
financial books and records of the Fund. For these services, Ultimus receives
from the Fund a monthly fee of $3,500, plus an asset based fee equal to .01% of
the Fund's average daily net assets up to $500 million and .005% of such assets
in excess of $500 million. Additionally, on a monthly basis, Ultimus receives $5
per trade for accounting for portfolio trades in excess of two hundred. For the
year ended May 31, 2005, Ultimus was paid $111,839 under the fund accounting
agreement. In addition, the Fund reimburses certain out-of-pocket expenses
incurred by Ultimus in obtaining valuations of the Fund's portfolio securities.
DISTRIBUTION AGREEMENT
Under the terms of a Distribution Agreement between the Trust and Ultimus Fund
Distributors, LLC (the "Distributor"), the Distributor serves as principal
underwriter and national distributor for the shares of the Fund. The Fund's
shares are sold on a no-load basis and, therefore, the Distributor receives no
sales commissions or sales loads for providing services to the Fund. The
Distributor is an affiliate of Ultimus.
DISTRIBUTION PLAN
The Fund has adopted a plan of distribution pursuant to Rule 12b-1 under the
1940 Act (the "Plan") for Class R shares, which permits Class R to pay for
expenses incurred in the distribution and promotion of Class R shares. Under the
Plan, Class R may pay compensation to any broker-dealer with whom the
Distributor or the Fund, on behalf of Class R shares, has entered into a
contract to distribute Class R shares, or to any other qualified financial
services firm, for distribution and/or shareholder-related services with respect
to shares held or purchased by their respective customers in connection with the
purchase of shares attributable to their efforts. The amount of payments under
the Plan in any year shall not exceed .25% annually of the average daily net
assets allocable to Class R shares. During the year ended May 31, 2005, the Fund
paid Class R distribution expenses of $463,237 pursuant to the Plan.
4. OPTIONS CONTRACTS
A summary of option contracts written during the year ended May 31, 2005 is as
follows:
- --------------------------------------------------------------------------------
OPTION OPTION
CONTRACTS PREMIUMS
- --------------------------------------------------------------------------------
Options outstanding at beginning of year 33,495 $ 2,457,627
Options written 148,108 15,104,306
Options canceled in a closing purchase transaction (23,538) (1,950,103)
Options exercised (73,513) (8,689,223)
Options expired (80,822) (6,458,736)
------------ ------------
Options outstanding at end of year 3,730 $ 463,871
============ ============
- --------------------------------------------------------------------------------
23
THE ARBITRAGE FUND
Notes to the Financial Statements (Continued)
May 31, 2005
================================================================================
5. CAPITAL SHARE TRANSACTIONS
Proceeds and payments on capital shares as shown in the Statement of Changes in
Net Assets are the result of the following capital transactions for the years
shown:
- --------------------------------------------------------------------------------
Year Year
Ended Ended
May 31, May 31,
2005 2004
- --------------------------------------------------------------------------------
CLASS R
Shares sold 3,553,278 19,944,187
Shares issued in reinvestment of distributions 572,406 607,024
Shares redeemed (11,968,047) (12,071,428)
----------- -----------
Net increase (decrease) in shares outstanding (7,842,363) 8,479,783
Shares outstanding at beginning of year 19,124,744 10,644,961
----------- -----------
Shares outstanding at end of year 11,282,381 19,124,744
=========== ===========
CLASS I
Shares sold 4,445,038 14,818,551
Shares issued in reinvestment of distributions 359,150 171,224
Shares redeemed (10,390,377) (1,489,330)
----------- -----------
Net increase (decrease) in shares outstanding (5,586,189) 13,500,445
Shares outstanding at beginning of year 13,500,445 --
----------- -----------
Shares outstanding at end of year 7,914,256 13,500,445
=========== ===========
- --------------------------------------------------------------------------------
24
THE ARBITRAGE FUND
Notes to the Financial Statements (Continued)
May 31, 2005
================================================================================
6. FOREIGN CURRENCY TRANSLATION
Amounts denominated in or expected to settle in foreign currencies are
translated to U.S. dollars based on exchange rates on the following basis:
A. The market values of investment securities and other assets and liabilities
are translated at the closing rate of exchange each day.
B. Purchases and sales of investment securities and income and expenses are
translated at the rate of exchange prevailing on the respective dates of such
transactions.
C. The Fund does not isolate that portion of the results of operations caused by
changes in foreign exchange rates on investment from those caused by changes in
market prices of securities held. Such fluctuations are included with the net
realized and unrealized gains or losses on investments.
Reported net realized foreign exchange gains or losses arise from 1) purchases
and sales of foreign currencies, 2) currency gains or losses realized between
the trade and settlement dates on securities transactions and 3) the difference
between the amounts of dividends, interest and foreign withholding taxes
recorded on the Fund's books, and the U.S. dollar equivalent of the amounts
actually received or paid. Reported net unrealized foreign exchange gains and
losses arise from changes in the value of assets and liabilities, other than
investment securities, resulting from changes in exchange rates.
7. CONTINGENCIES AND COMMITMENTS
The Fund indemnifies the Trust's officers and trustees for certain liabilities
that might arise from their performance of their duties to the Fund.
Additionally, in the normal course of business the Fund enters into contracts
that contain a variety of representations and warranties and which provide
general indemnifications. 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.
25
THE ARBITRAGE FUND
Notes to the Financial Statements (Continued)
May 31, 2005
================================================================================
8. SECURITIES LENDING
In order to generate additional income, the Fund may, from time to time, lend
its portfolio securities to broker-dealers, banks or institutional borrowers of
securities. The Fund must receive 100% collateral in the form of cash or U.S.
government securities. This collateral must be valued daily and, should the
market value of the loaned securities increase, the borrower must furnish
additional collateral to the Fund. During the time portfolio securities are on
loan, the borrower pays the Fund any dividends or interest paid on such
securities. Loans are subject to termination by the Fund or the borrower at any
time. While the Fund does not have the right to vote securities on loan, it has
the right to terminate the loan and regain the right to vote if that is
considered important with respect to the investment. In the event the borrower
defaults in its obligation to the Fund, the Fund bears the risk of delay in the
recovery of its portfolio securities and the risk of loss of rights in the
collateral. The Fund will only enter into loan arrangements with broker-dealers,
banks or other institutions which the Adviser has determined are creditworthy
under guidelines established by the Trustees. There were no securities on loan
as of May 31, 2005.
During the year ended May 31, 2005, the Fund earned $1,358 in securities lending
income.
9. FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
The Fund enters into forward foreign currency exchange contracts as a way of
managing foreign exchange rate risk. The Fund may enter into these contracts for
the purchase or sale of a specific foreign currency at a fixed price on a future
date as a hedge or cross-hedge against either specific transactions or portfolio
positions. The objective of the Fund's foreign currency hedging transactions is
to reduce risk that the U.S. dollar value of the Fund's securities denominated
in foreign currency will decline in value due to changes in foreign currency
exchange rates. All foreign currency exchange contracts are "marked-to market"
daily at the applicable translation rates resulting in unrealized gains or
losses. Risks may arise upon entering into these contracts from the potential
inability of counterparties to meet the terms of their contracts and from
unanticipated movements in the value of a foreign currency relative to the U.S.
dollar.
26
THE ARBITRAGE FUND
Notes to the Financial Statements (Continued)
May 31, 2005
================================================================================
As of May 31, 2005, the Fund had forward foreign currency exchange contracts
outstanding as follows:
- ---------------------------------------------------------------------------------------
NET UNREALIZED
TO RECEIVE APPRECIATION
SETTLEMENT DATE (TO DELIVER) INITIAL VALUE MARKET VAL (DEPRECIATION)
- ---------------------------------------------------------------------------------------
Contracts to Sell
06/01/05 ......... (622,138) AUD $ 473,384 $ 471,488 $ 1,896
06/02/05 ......... (624,875) AUD 476,777 473,562 3,215
06/09/05 ......... (7,500,000) AUD 5,889,000 5,679,477 209,523
06/29/05 ......... (15,000,000) CAD 12,283,202 11,968,872 314,330
06/09/05 ......... (1,500,000) EUR 1,986,450 1,852,566 133,884
07/27/05 ......... (310,000) EUR 403,527 383,395 20,132
06/08/05 ......... (6,500,000) GBP 12,436,450 11,841,440 595,010
06/30/05 ......... (93,890) GBP 177,745 171,120 6,625
07/27/05 ......... (1,430,000) GBP 2,715,251 2,599,391 115,860
08/08/05 ......... (1,280,000) HKD 164,770 164,527 243
------------ ------------ ------------
Total Sell Contracts $ 37,006,556 $ 35,605,838 $ 1,400,718
------------ ------------ ------------
Contracts to Buy
06/01/05 ......... 1,043,584 AUD $ (794,064) $ (790,882) $ (3,182)
06/02/05 ......... 1,052,516 AUD (803,072) (797,651) (5,421)
06/09/05 ......... 4,000,000 AUD (3,088,400) (3,029,054) (59,346)
06/29/05 ......... 3,800,000 CAD (3,024,755) (3,032,114) 7,359
06/09/05 ......... 1,000,000 EUR (1,292,580) (1,235,044) (57,536)
06/01/05 ......... 174,046 GBP (316,851) (317,209) 358
06/03/05 ......... 173,670 GBP (316,618) (316,472) (146)
06/08/05 ......... 1,750,000 GBP (3,295,850) (3,188,080) (107,770)
------------ ------------ ------------
Total Buy Contracts $(12,932,190) $(12,706,506) $ (225,684)
------------ ------------ ------------
Net Contracts ...... $ 24,074,366 $ 22,899,332 $ 1,175,034
============ ============ ============
- ---------------------------------------------------------------------------------------
AUD - Australian Dollar CAD - Canadian Dollar EUR - Euro Dollar
GBP - British Pound Sterling HKD - Hong Kong Dollar
- ---------------------------------------------------------------------------------------
10. EQUITY SWAP CONTRACTS
The Fund has entered into equity swap contracts. An equity swap provides the
Fund with exposure to any appreciation or depreciation as well as dividends on a
security from a counterparty to the contract. 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. As of May 31, 2005, the Fund had long and short equity swap
contracts outstanding of $10,427,302 and $164,303, respectively.
11. NEW SERVICE AGREEMENTS
Effective July 25, 2005, administrative services and fund accounting services
are being provided by SEI Investments, Inc. and transfer agent services are
being provided by DST Systems, Inc. Additionally, effective July 25, 2005,
distribution services are being provided by SEI Investments Distribution Co.
27
THE ARBITRAGE FUND
Report of Independent Registered Public Accounting Firm
================================================================================
To the Board of Trustees and Shareholders
The Arbitrage Fund
We have audited the accompanying statement of assets and liabilities of The
Arbitrage Fund (the "Fund"), including the schedule of investments as of May 31,
2005, and the related statement of operations for the year then ended, the
statement of changes in net assets for each of the two years in the period then
ended, and the financial highlights for each of the four years in the period
then ended. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits. The financial highlights for the period September 17, 2000 (commencement
of operations) through May 31, 2001 have been audited by other auditors, whose
report dated July 10, 2001 expressed an unqualified opinion on such financial
highlights.
We conducted our audits 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 and financial highlights are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. Our procedures included confirmation of
securities owned as of May 31, 2005 by correspondence with the custodian and
brokers. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of The
Arbitrage Fund as of May 31, 2005, the results of its operations for the year
then ended, the changes in its net assets for each of the two years in the
period then ended, and the financial highlights for each of the four years in
the period then ended, in conformity with accounting principles generally
accepted in the United States of America.
TAIT, WELLER & BAKER
Philadelphia, Pennsylvania
June 29, 2005
28
THE ARBITRAGE FUND
About Your Fund's Expenses (Unaudited)
================================================================================
We believe it is important for you to understand the impact of costs on your
investment. As a shareholder of the Fund, you incur two types of costs: (1)
transaction costs, including redemption fees; and (2) ongoing costs, including
management fees, distribution (12b-1) fees, and other Fund expenses. The
following examples are 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.
A fund's expenses are expressed as a percentage of its average net assets. This
figure is known as the expense ratio. The following examples are intended to
help you understand the 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 examples below are based on an investment of $1,000 made at the
beginning of the period shown and held for the entire period.
The table below illustrates the Fund's costs in two ways:
ACTUAL FUND RETURN - This section helps you to estimate the actual expenses that
you paid over the period. The "Ending Account Value" shown is derived from the
Fund's actual return, and the third column shows the dollar amount of operating
expenses that would have been paid by an investor who started with $1,000 in the
Fund. You may use the information here, together with the amount you invested,
to estimate the expenses that you paid over the period.
To do so, 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
given for the Fund under the heading "Expenses Paid During Period."
HYPOTHETICAL 5% RETURN - This section is intended to help you compare the Fund's
costs with those of other mutual funds. It assumes that the Fund had an annual
return of 5% before expenses during the period shown, but that the expense ratio
is unchanged. In this case, because the return used is not the Fund's actual
returns, the results do not apply to your investment. The example is useful in
making comparisons because the Securities and Exchange Commission requires all
mutual funds to calculate expenses based on a 5% return. You can assess the
Fund's costs by comparing this hypothetical example with the hypothetical
examples that appear in shareholder reports of other funds.
Note that expenses shown in the table are meant to highlight and help you
compare ongoing costs only. The Fund does not charge a front-end sales load.
However, a redemption fee of 2% is applied on the sale of shares held within 90
days of the date of purchase and does not apply to the redemption of shares
acquired through reinvestment of dividends and other distributions.
The calculations assume no shares were bought or sold during the period. Your
actual costs may have been higher or lower, depending on the amount of your
investment and the timing of any purchases or redemptions.
More information about the Fund's expenses, including annual expense ratios
since inception, can be found in this report. For additional information on
operating expenses and other shareholder costs, please refer to the Fund's
prospectus.
29
THE ARBITRAGE FUND
About Your Fund's Expenses (Unaudited) (Continued)
================================================================================
THE ARBITRAGE FUND - CLASS R
- --------------------------------------------------------------------------------
BEGINNING ENDING
ACCOUNT VALUE ACCOUNT VALUE EXPENSES PAID
DECEMBER 1, 2004 MAY 31, 2005 DURING PERIOD*
- --------------------------------------------------------------------------------
Based on Actual Fund Return $ 1,000.00 $ 992.50 $ 11.08
Based on Hypothetical 5% Return
(before expenses) $ 1,000.00 $ 1,013.81 $ 11.20
- --------------------------------------------------------------------------------
* Expenses are equal to the Arbitrage Fund - Class R annualized expense ratio
of 2.23% for the period, multiplied by the average account value over the
period, multiplied by 182/365 (to reflect the one-half year period).
THE ARBITRAGE FUND - CLASS I
- --------------------------------------------------------------------------------
BEGINNING ENDING
ACCOUNT VALUE ACCOUNT VALUE EXPENSES PAID
DECEMBER 1, 2004 MAY 31, 2005 DURING PERIOD*
- --------------------------------------------------------------------------------
Based on Actual Fund Return $ 1,000.00 $ 994.10 $ 9.84
Based on Hypothetical 5% Return
(before expenses) $ 1,000.00 $ 1,015.06 $ 9.95
- --------------------------------------------------------------------------------
* Expenses are equal to the Arbitrage Fund - Class I annualized expense ratio
of 1.98% for the period, multiplied by the average account value over the
period, multiplied by 182/365 (to reflect the one-half year period).
Federal Tax Information (Unaudited)
================================================================================
In accordance with federal tax requirements, the following provides shareholders
with information concerning distributions from ordinary income and net realized
gains made by the Fund during the year ended May 31, 2005. For the fiscal year
ended May 31, 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 Fund intends to designate up to a maximum amount
of $10,778,315 as taxed at a maximum rate of 15%. Complete information will be
computed and reported in conjunction with your 2005 Form 1099-DIV.
30
THE ARBITRAGE FUND
Other Information (Unaudited)
================================================================================
A description of the policies and procedures that the Fund uses to vote proxies
relating to portfolio securities is available without charge upon request by
calling toll-free 1-800-295-4485, or on the Securities and Exchange Commission's
("SEC") website at http://www.sec.gov. Information regarding how the Fund voted
proxies relating to portfolio securities during the most recent 12-month period
ended June 30 is available without charge upon request by calling toll-free
1-800-295-4485, or on the SEC's website at http://www.sec.gov.
The Trust files a complete listing of portfolio holdings for the Fund with the
SEC as of the first and third quarters of each fiscal year on Form N-Q. The
filings will be available upon request, by calling 1-800-295-4485. Furthermore,
you will be able to obtain a copy of the filing on the SEC's website at
http://www.sec.gov. The Trust's Forms N-Q may also be reviewed and copied at the
SEC's Public Reference Room in Washington, DC, and information on the operation
of the Public Reference Room may be obtained by calling 1-800-SEC-0330.
31
THE ARBITRAGE FUND
Trustees' Renewal Of Advisory Agreement (Unaudited)
================================================================================
The Board of Trustees of The Arbitrage Fund (the "Fund"), including a majority
of its independent Trustees, approved the continuance of the Fund's investment
advisory agreement with Water Island Capital, LLC, the Fund's investment adviser
(hereafter referred to as the "Adviser"). The board determined that continuance
of the investment advisory agreement was in the best interests of the Fund and
its shareholders.
The board based its decision upon its most recent review of the Adviser's
investment personnel, portfolio management process, and performance. The
Trustees discussed the factors below, among others. However, no single factor
determined whether the board approved the continuation of the investment
advisory agreement. Rather, it was the totality of the factors that led to the
decision.
NATURE, EXTENT, AND QUALITY OF SERVICES
The board considered the experience of the personnel managing the Fund's assets
as well as the quality of the Fund's investment management over both short- and
long-term periods. The board concluded the Adviser has provided high quality
consistent service to the Fund and its shareholders.
COST
The board considered the Fund's overall expense ratio, comparing it to other
similarly managed mutual funds. In its consideration of the Fund's overall
expense ratio, the board also considered the Adviser's long term commitment to
cap operating expenses by waiving a portion of its advisory fee. The board
during its review of costs considered the Fund's advisory fee, comparing the fee
to other funds offering similar investment strategies.
The board concluded even though the Fund's overall expense ratio is higher than
the average of comparably managed funds, they believe shareholders are receiving
a quality investment option for a reasonable price. The board also concluded
that although the advisory fees payable to the Adviser are in the higher range
of fees for other comparably managed funds, they believe the fees to be
reasonable given the quality of services provided by the Adviser and the
complexity of investment strategies implemented by the Adviser.
PROFITABILITY OF ADVISER
The board considered the Adviser's profitability with regards to its management
of the Fund, concluding that the Adviser's profitability was not excessive and
therefore was a secondary factor in connection with the evaluation of advisory
fees paid by the Fund.
32
THE ARBITRAGE FUND
Trustees' Renewal Of Advisory Agreement (Unaudited) (Continued)
================================================================================
INVESTMENT PERFORMANCE
The board considered the Fund's short- and long-term performance, including any
periods of outperformance or underperformance of relevant benchmarks and peer
groups. The board concluded that the Fund has performed consistent with its
investment strategy. The Fund's returns have trailed the average performance of
its peer group as well the broad U.S. stock market (as measured by the S&P 500
Index) over the short-term (1 year) while performance when measured over a
longer term (4 + years) has exceeded the average performance of its peer group
as well the broad U.S. stock market. Information about the Fund's historical
performance can be found on page 3 of this Annual Report.
ECONOMIES OF SCALE AND ANCILLARY BENEFITS
The board concluded that as a result of the significant decrease in Fund assets
over the past year, at the present time it would not be relevant to consider the
extent to which economies of scale would be realized as the Fund grows, and
whether fee levels reflect potential future economies of scale.
The board also considered the "ancillary benefits" to the Adviser, viewing these
as secondary factors in connection with the evaluation of the reasonableness of
the advisory fees paid by the Fund. The board did consider the level of soft
dollar activity, concluding that as a result of the Fund being the Adviser's
only client, benefits derived from these trades are going directly to the Fund
and its shareholders.
33
THE ARBITRAGE FUND
Board of Trustees and Officers (Unaudited)
================================================================================
Overall responsibility for management of the Fund rests with the Board of
Trustees. The Trustees serve during the lifetime of the Trust and until its
termination, or until death, resignation, retirement or removal. The Trustees,
in turn, elect the officers of the Fund to actively supervise its day-to-day
operations. The officers have been elected for an annual term. The following are
the Trustees and executive officers of the Fund:
POSITION HELD LENGTH OF
TRUSTEE ADDRESS AGE WITH THE TRUST TIME SERVED
- -----------------------------------------------------------------------------------------------------------------
*John S. Orrico, CFA 650 Fifth Avenue 45 President, Secretary, Since May 2000
New York, NY 10019 Treasurer and Trustee
*Joel C. Ackerman 295 Central Park West 60 Trustee Since May 2000
New York, NY 10024
John C. Alvarado 575 Madison Ave, 10th Floor 45 Trustee Since December 2003
New York, NY 10022
Burtt R. Ehrlich One Landmark Square, 22nd Floor 66 Trustee Since March 2005
Stanford, CT 06901
Jay N. Goldberg 660 Madison Avenue 64 Trustee Since May 2000
New York, NY 10021
Matthew Hemberger 650 Fifth Avenue 45 Vice President and
New York, NY 10019 Chief Compliance Officer
* Messrs Orrico and Ackerman are "interested persons" of the Trust within the meaning of Section 2(a)(19) of
the Investment Company Act of 1940.
Each Trustee oversees one portfolio of the Trust. The principal occupations of
the Trustees and executive officers of the Fund during the past five years and
public directorships held by the Trustees are set forth below:
John S. Orrico is General Partner of the Adviser. Prior to January 2000, he was
Portfolio Manager to private trusts and entities at Lindemann Capital Partners,
L.P. (a financial management firm).
Joel C. Ackerman is currently a consultant to the Fund's Adviser. During 2003,
he was a Partner in Crossroads Investments LP and a Partner with LRL Capital
(hedge fund). Prior to September 2002, he was a Partner of Ardsley Partners
(hedge fund).
John C. Alvarado is a Managing Member of Power Capital Partners, LLC which is a
financial advisory and consulting firm. He is currently Chief Financial Officer
of Wax Inc. (men's retail apparel), a Managing Director of Energy Finance
Merchants, LLC, and Managing Member of Gordon Alvarado LLC. From 1995 to 2000,
he was senior Vice President, Co-Founder and Partner of Stratum Group LP, which
is private a equity investment firm.
Jay N. Goldberg is Senior Managing Director of Hudson Ventures (a venture
capital company).
Matthew Hemberger is Chief Compliance Officer of the Adviser and Chief
Compliance Officer to the Trust. Prior to March 2001, he was an Analyst,
Assistant Portfolio Manager, and CFO at Lindemann Capital Partners, L.P.
Additional information about members of the Board of Trustees and Officers is
available in the Statement of Additional Information (SAI). To obtain a free
copy of the SAI, please call 1-800-295-4485.
34
[GRAPHIC OMITTED]
THE ARBITRAGE FUND
A SERIES OF THE ARBITRAGE FUNDS
ADVISER WATER ISLAND CAPITAL, LLC
650 Fifth Avenue, 6th Floor
New York, NY 10019
DISTRIBUTOR SEI INVESTMENTS DISTRIBUTION CO.
Oaks, PA 19456
TRANSFER AGENT DST SYSTEMS, INC.
P.O. Box 219842
Kansas City, MO 64121-9842
CUSTODIAN MELLON BANK, N.A.
One Mellon Bank Center
Pittsburgh, PA 15258
ITEM 2. CODE OF ETHICS.
As of the end of the period covered by this report, the registrant has adopted a
code of ethics that applies to the registrant's principal executive officer,
principal financial officer, principal accounting officer or controller, or
persons performing similar functions, regardless of whether these individuals
are employed by the registrant or a third party. Pursuant to Item 11(a)(1), a
copy of registrant's code of ethics is filed as an exhibit to this Form N-CSR.
During the period covered by this report, the code of ethics has not been
amended. The registrant has not granted any waivers, including implicit waivers,
from the provisions of the code of ethics.
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.
The registrant's board of trustees has determined that the registrant has at
least one audit committee financial expert serving on its audit committee. The
name of the audit committee financial expert is John C. Alvarado. Mr. Alvarado
is "independent" for purposes of this Item.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
(a) AUDIT FEES. The aggregate fees billed for professional services
rendered by the principal accountant for the audit of the registrant's
annual financial statements or for services that are normally provided
by the accountant in connection with statutory and regulatory filings
or engagements were $xx,xxx with respect to the registrant's fiscal
year ended May 31, 2005. The aggregate fees billed for professional
services rendered by the principal accountant for the audit of the
registrant's annual financial statements or for services that are
normally provided by the accountant in connection with statutory and
regulatory filings or engagements were $15,500 with respect to the
registrant's fiscal year ended May 31, 200.
(b) AUDIT-RELATED FEES. No fees were billed in either of the last two
fiscal years for assurance and related services by the principal
accountant that are reasonably related to the performance of the audit
of the registrant's financial statements and are not reported under
paragraph (a) of this Item.
(c) TAX FEES. No fees were billed in either of the last two fiscal years
for professional services rendered by the principal accountant for tax
compliance, tax advice, and tax planning.
(d) ALL OTHER FEES. No fees were billed in either of the last two fiscal
years for products and services provided by the principal accountant,
other than the services reported in paragraphs (a) through (c) of
this Item.
(e)(1) The audit committee has not adopted pre-approval policies and
procedures described in paragraph (c)(7) of Rule 2-01 of Regulation
S-X.
(e)(2) None of the services described in paragraph (b) through (d) of this
Item were approved by the audit committee pursuant to paragraph
(c)(7)(i)(C) of Rule 2-01 of Regulation S-X.
(f) Less than 50% of hours expended on the principal accountant's
engagement to audit the registrant's financial statements for the most
recent fiscal year were attributed to work performed by persons other
than the principal accountant's full-time, permanent employees.
(g) No non-audit fees were billed in either of the last two fiscal years
by the registrant's accountant for services rendered to the
registrant, and rendered to the registrant's investment adviser (not
including any sub-adviser whose role is primarily portfolio management
and is subcontracted with or overseen by another investment adviser),
and any entity controlling, controlled by, or under common control
with the adviser that provides ongoing services to the registrant.
(h) The principal accountant has not provided any non-audit services to
the registrant's investment adviser (not including any sub-adviser
whose role is primarily portfolio management and is subcontracted with
or overseen by another investment adviser), and any entity
controlling, controlled by, or under common control with the
investment adviser that provides ongoing services to the registrant.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
Not applicable
ITEM 6. SCHEDULE OF INVESTMENTS.
Not applicable [schedule filed with Item 1]
ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END
MANAGEMENT INVESTMENT COMPANIES.
Not applicable
ITEM 8. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT
COMPANY AND AFFILIATED PURCHASERS.
Not applicable
ITEM 9. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The registrant has not adopted procedures by which shareholders may recommend
nominees to the registrant's board of trustees.
ITEM 10. CONTROLS AND PROCEDURES.
(a)(1) Based on his evaluation of the registrant's disclosure controls and
procedures (as defined in Rule 30a-3(c) under the Investment Company Act of
1940) as of a date within 90 days of the filing date of this report, the
registrant's principal executive officer and principal financial officer has
concluded that such disclosure controls and procedures are reasonably designed
and are operating effectively to ensure that material information relating to
the registrant, including its consolidated subsidiaries, is made known to him by
others within those entities, particularly during the period in which this
report is being prepared, and that the information required in filings on Form
N-CSR is recorded, processed, summarized, and reported on a timely basis.
(a)(2) There were no changes in the registrant's internal control over financial
reporting (as defined in Rule 30a-3(d) under the Investment Company Act of 1940)
that occurred during the registrant's most recent fiscal half-year (the
registrant's second fiscal half-year in the case of an annual report) that have
materially affected, or are reasonably likely to materially affect, the
registrant's internal control over financial reporting.
ITEM 11. EXHIBITS.
File the exhibits listed below as part of this Form. Letter or number the
exhibits in the sequence indicated.
(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: Attached hereto
(a)(2) A separate certification for each principal executive officer and
principal financial officer of the registrant as required by Rule 30a-2(a) under
the Act (17 CFR 270.30a-2(a)): Attached hereto
(a)(3) Any written solicitation to purchase securities under Rule 23c-1 under
the Act (17 CFR 270.23c-1) sent or given during the period covered by the report
by or on behalf of the registrant to 10 or more persons: Not applicable
(b) Certifications required by Rule 30a-2(b) under the Act (17 CFR
270.30a-2(b)): Attached hereto
Exhibit 99.CODE ETH Code of Ethics
Exhibit 99.CERT Certifications required by Rule 30a-2(a) under the Act
Exhibit 99.906CERT Certifications required by Rule 30a-2(b) under the Act
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 Arbitrage Funds
--------------------------------------------------------------
By (Signature and Title)* /s/ John S. Orrico
--------------------------------------------
John S. Orrico, President and Treasurer
Date July xx, 2005
-----------------------------
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/ John S. Orrico
--------------------------------------------
John S. Orrico, President and Treasurer
Date July xx, 2005
-----------------------------
* Print the name and title of each signing officer under his or her signature.