<PAGE> 1
November 16, 1999
Dear Fellow Shareholder:
Fiscal 1999 was a record year for The Merger Fund(R). As previously
reported, the Fund gained 21.3% in the 12 months ended September 30,
substantially exceeding our rate-of-return targets. This above-trendline showing
was attributable to the continued rapid pace of M&A activity, attractive
arbitrage spreads and a highly selective investment approach that enabled us to
avoid a number of broken deals. Out of more than a hundred arbitrage positions
held by The Merger Fund(R) in fiscal 1999, just one transaction failed to be
completed. Not only did the Fund post strong absolute returns, but our risk
profile also remained extremely favorable. We can again report that, based on
Morningstar data for the three years ended September 30, The Merger Fund(R)
showed the most consistent monthly returns, the least sensitivity to market
fluctuations and the lowest Morningstar risk among approximately 2,000 equity
mutual funds.
The mix of merger activity has changed somewhat since our last annual
report, but the percentage of unsolicited, or hostile, takeover attempts has
remained low. Although the Fund did invest in several hostile transactions
earlier in the year, Chart 1 shows that friendly deals represented 100% of our
arbitrage holdings as of September 30. As we have noted previously, hostile bids
are relatively uncommon because, more often than not, they don't succeed. It
takes a rare confluence of favorable elements for an unsolicited offer to carry
the day, and even when the target fails to remain independent, it frequently
ends up in the hands of a white knight. In some cases, moreover, the failure to
complete a hostile takeover leaves the would-be acquirer vulnerable to a
re-rating by Wall Street analysts and portfolio managers; the unsuccessful
effort may be viewed as an admission that the bidder needs something it doesn't
have. The urge to merge, however, often takes on a life of its own, and we
anticipate that hostile deals will remain a small but high-profile part of the
takeover scene absent major changes in the law, regulation or economic and
market conditions.
Chart 2 shows that virtually all of the acquisitions in which the Fund has
invested are strategic in nature, meaning deals that involve a corporate
buyer-generally operating in the same industry as the target-whose management
sees the transaction as a quicker and more cost-effective alternative to
building the business organically. As was the case last year and for most of the
decade, highly leveraged, financially driven takeovers of publicly traded
companies remain relatively infrequent. After an 18-year bull market, the floor
of the New York Stock Exchange is not the best place to look for undervalued
corporate assets. With public market values often exceeding private market
values, there is little incentive for LBO firms to take companies private. And
even when a suitable candidate is identified, the financial buyer may well find
itself in competition with corporate players armed with richly valued shares.
From an arbitrage standpoint, the continued preponderance of strategic deals is
clearly a good thing. Some LBO firms appear to view their acquisition agreements
as a free call option on the target company during the pendency of the
transaction. Should the target's interim results fall short of expectations or
leveraged financing become more difficult to obtain, these buyers may be quick
to cut the takeout price or abandon the deal altogether. Not all strategic
acquisitions are accident-proof, of course, but they are generally less
vulnerable to the inevitable bumps in the road along the way.
Chart 3 shows the type of consideration to be received by the selling
company's shareholders in transactions in which The Merger Fund(R) held
positions at the end of its fiscal year. Stock remains the acquisition currency
of choice, to an even greater extent than last year. Seventy percent of the
deals in our portfolio, measured as a percentage of the Fund's assets, involve
at least some stock, up from
<PAGE> 2
53% a year earlier. In addition to taking advantage of today's lofty equity
valuations, stock transactions permit pooling-of-interests accounting treatment,
an approach that allows the acquiring company to avoid earnings dilution tied to
the amortization of goodwill. Beginning in January of 2001, however, pooling may
no longer be permitted, which means that all takeovers -- whether for cash or
stock -- must be done under purchase accounting. The prospective elimination of
pooling is likely to help keep M&A activity at robust levels over the next year,
but we don't expect mergers to grind to a halt in 2001. That's because many
acquisitive companies are already attempting to convince Wall Street that "cash
earnings" (i.e., earnings before depreciation and amortization of goodwill) are
the best measure of corporate performance, and cash earnings are not penalized
under purchase accounting. It is also worth noting that purchase accounting is
subject to fewer conditions than pooling and therefore offers would-be acquirers
greater flexibility, especially in hostile situations, so that we may see
increased use of this accounting technique well before it becomes mandatory.
Chart 4 shows our investments classified by economic sector. As has been
the case each year since the Fund's inception, financial services, a category
that includes banks, S&Ls, insurers and investment advisory companies,
represents the largest segment of our portfolio (21%). With the repeal of
Glass-Steagall, consolidation in this sector seems likely to continue to run at
a healthy clip. Telecommunications, which last year ranked fourth at seven
percent of the portfolio, has jumped to second place this year, representing 16%
of our holdings. Telecom service providers appear determined to expand their
geographic footprints, while their equipment suppliers see acquisitions as a
means of offering a broader array of products geared to the convergence of
voice, data and video. These same trends help explain recent acquisition
activity involving cable TV companies, which are included in our media category
(14%). Also included among the Fund's holdings in this sector are two Internet
advertising companies, whose presence in our portfolio reflects the growing
importance of the Internet and the fact that many companies in cyberspace view
strategic combinations as one way to stay ahead of the curve in an industry
undergoing dramatic change. The Fund's Internet investments have worked out
extremely well so far, and we anticipate playing many more such deals in the
years ahead.
Last year's annual report was written in the wake of severe turbulence in
the financial markets that buffeted arbitrageurs and conventional money managers
alike. Having been through such periods before, we were unusually optimistic
about our prospects and concluded the report by saying, "We look forward to
writing next year's letter!" Not all of our comments have proven to be as
prescient, but we are comfortable predicting that fiscal 2000 will be another
excellent year for our unique investment vehicle.
Sincerely,
/s/ FREDERICK W. GREEN
Frederick W. Green
President
2
<PAGE> 3
THE MERGER FUND(R)
CHART 1
PORTFOLIO COMPOSITION
<TABLE>
<CAPTION>
HOSTILE FRIENDLY
<S> <C> <C>
BY THE TYPE OF DEAL* 0.0% 100.0%
</TABLE>
CHART 2
PORTFOLIO COMPOSITION
<TABLE>
<CAPTION>
FINANCIAL STRATEGIC
<S> <C> <C>
BY THE TYPE OF BUYER* 1.6% 98.4%
</TABLE>
*DATA AS OF 9/30/99
3
<PAGE> 4
THE MERGER FUND(R)
CHART 3
PORTFOLIO COMPOSITION
<TABLE>
<CAPTION>
STOCK WITH
STOCK WITH FIXED FLEXIBLE EXCHANGE
EXCHANGE RATIO RATIO CASH & STOCK CASH UNDETERMINED
<S> <C> <C> <C> <C> <C>
BY DEAL TERMS* 25.3% 21.5% 22.8% 29.7% 0.7%
</TABLE>
CHART 4
PORTFOLIO COMPOSITION
<TABLE>
<CAPTION>
CUSTOMER
FINANCIAL BASIC BUSINESS CONSUMER NON- CAPITAL
SERVICES TELECOMMUNICATIONS MEDIA TECHNOLOGY INDUSTRIES HEALTHCARE SERVICES SERVICES DURABLES GOODS
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BY SECTOR* 21.4% 16.3% 14.5% 11.9% 8.7% 8.6% 7.2% 3.9% 3.2% 2.5%
<CAPTION>
CONSUMER
ENERGY MISCELLANEOUS DURABLES
<S> <C> <C> <C>
BY SECTOR* 1.2% 0.5% 0.1%
</TABLE>
*DATA AS OF 9/30/99
4
<PAGE> 5
COMPARISON OF CHANGE IN VALUE OF $10,000 INVESTMENT
IN THE MERGER FUND AND THE S&P 500
[COMPARISON LINE GRAPH]
<TABLE>
<CAPTION>
S&P 500 THE MERGER FUND
------- ---------------
<S> <C> <C>
1/89 10000.00 10000.00
9751.00 10099.00
9978.00 10396.00
10496.00 10472.00
10921.00 10540.00
10859.00 10676.00
11840.00 10913.00
12071.00 11168.00
12022.00 10625.00
11743.00 10184.00
11982.00 10209.00
9/89 12270.00 10680.00
11446.00 10057.00
11594.00 10226.00
11901.00 10571.00
11604.00 10637.00
12735.00 10917.00
12649.00 10973.00
12609.00 10739.00
11469.00 10683.00
10911.00 9871.00
10865.00 10179.00
11568.00 10674.00
9/90 11890.00 10796.00
12407.00 10846.00
13295.00 10876.00
13617.00 11195.00
13649.00 11504.00
14238.00 11574.00
13585.00 11754.00
14219.00 11973.00
14556.00 12043.00
14312.00 12063.00
14504.00 12162.00
13920.00 12471.00
9/91 15512.00 12614.00
15223.00 12825.00
15420.00 12825.00
15120.00 12899.00
15564.00 12889.00
15640.00 12815.00
15407.00 12741.00
16037.00 13131.00
15709.00 13279.00
15893.00 13385.00
15948.00 13490.00
16491.00 13026.00
9/92 16693.00 13288.00
16833.00 13566.00
17062.00 13655.00
17423.00 13588.00
17001.00 13766.00
17456.00 13944.00
17507.00 14333.00
17437.00 14613.00
18099.00 14781.00
17960.00 14881.00
18331.00 15104.00
18156.00 15271.00
9/93 18376.00 15644.00
19001.00 15825.00
18484.00 15764.00
17678.00 15801.00
17904.00 15970.00
18198.00 16078.00
17752.00 16223.00
18334.00 16380.00
19086.00 16658.00
18618.00 16754.00
19037.00 16682.00
18344.00 16561.00
9/94 18616.00 16760.00
19098.00 17077.00
19843.00 17280.00
20428.00 17394.00
21029.00 17279.00
21870.00 17393.00
22373.00 17689.00
23111.00 18025.00
23181.00 18259.00
24159.00 18551.00
24072.00 18601.00
25129.00 18906.00
9/95 25614.00 19113.00
26484.00 19329.00
26730.00 19613.00
26987.00 19842.00
27383.00 19991.00
28090.00 20221.00
28196.00 20316.00
26950.00 20180.00
27519.00 20436.00
29068.00 20626.00
29870.00 20626.00
32129.00 20843.00
9/96 31493.00 21014.00
33461.00 21148.00
33722.00 21148.00
32336.00 21252.00
34266.00 21222.00
36353.00 21744.00
37982.00 22072.00
41005.00 22280.00
38709.00 22681.00
40830.00 22858.00
39466.00 22963.00
41294.00 23305.00
9/97 42004.00 23461.00
42470.00 23295.00
45532.00 23660.00
47863.00 23677.00
48347.00 24058.00
47515.00 24041.00
49444.00 24522.00
48920.00 24505.00
41846.00 23228.00
44529.00 23045.00
48149.00 23607.00
51067.00 24188.00
9/98 54008.00 24715.00
56266.00 24861.00
54516.00 25298.00
56697.00 25589.00
58891.00 25989.00
57501.00 26389.00
60692.00 27099.00
58799.00 27516.00
58510.00 27662.00
9/99 56907.00 27952.00
</TABLE>
Note: Westchester Capital Management, Inc. became sole adviser to the Fund in
January of 1989. Results for earlier periods are not shown. All figures
represent past performance and may not be indicative of future results. The
Fund's share price and return will vary, and Investors may have a gain or loss
when they redeem their shares.
<TABLE>
<CAPTION>
AVERAGE
ANNUAL TOTAL RETURN
-----------------------
1 YR. 5 YR. SINCE INCEPTION
----- ----- ---------------
<S> <C> <C> <C>
The Merger Fund.................................. 21.4% 10.8% 10.1%
</TABLE>
5
<PAGE> 6
THE MERGER FUND
SCHEDULE OF INVESTMENTS
SEPTEMBER 30, 1999
<TABLE>
<CAPTION>
SHARES VALUE
------ ------------
<C> <S> <C>
COMMON STOCKS -- 112.76%*
ADVERTISING -- 0.92%*
147,700 Outdoor Systems, Inc.**(1).................................. $ 5,280,275
------------
AGRICULTURAL BIOTECHNOLOGY -- 3.57%*
515,900 Pioneer Hi-Bred International, Inc.(1)(2)................... 20,539,269
------------
BANKS -- 11.96%*
772,300 Republic New York Corporation(1)............................ 47,448,181
695,000 UST Corp.(2)................................................ 21,371,250
------------
68,819,431
------------
BROKERAGE/INVESTMENT BANKING -- 1.81%*
353,900 EVEREN Capital Corporation(2)............................... 10,440,050
------------
CABLE & WIRE PRODUCTS -- 1.06%*
143,100 AFC Cable Systems, Inc.**(1)(2)............................. 6,081,750
------------
COMPUTER HARDWARE -- 0.55%*
150,000 Data General Corporation**(1)(2)............................ 3,159,375
------------
CABLE TV -- 8.06%*
341,700 Century Communications Corp. -- Class A**(1)................ 15,590,063
450,600 MediaOne Group, Inc.**(1)(2)................................ 30,781,612
------------
46,371,675
------------
COMMERCIAL PRINTING -- 0.59%*
91,900 World Color Press, Inc.**(2)................................ 3,423,275
------------
HOUSEHOLD PRODUCTS -- 3.53%*
402,500 Premark International, Inc.(2).............................. 20,326,250
------------
ELECTRONIC PRODUCTS AND DISTRIBUTION -- 5.02%*
701,800 Unitrode Corporation**(1)(2)................................ 28,861,525
------------
FARM EQUIPMENT -- 0.43%*
50,000 Case Corporation(4)......................................... 2,490,625
------------
FOOD RETAILERS -- 4.38%*
358,000 Hannaford Bros. Co.(2)...................................... 25,216,625
------------
GIFTWARE -- 0.06%*
73,554 Syratech Corporation(2)(6).................................. 367,770
------------
INDUSTRIAL PRODUCTS -- 0.59%*
137,100 Furon Company(2)............................................ 3,418,931
------------
INSTRUMENTS AND CONTROLS -- 1.30%*
67,200 Honeywell Inc.(1)........................................... 7,480,200
------------
</TABLE>
See notes to the financial statements.
6
<PAGE> 7
THE MERGER FUND
SCHEDULE OF INVESTMENTS (CONTINUED)
SEPTEMBER 30, 1999
<TABLE>
<CAPTION>
SHARES VALUE
------ ------------
<C> <S> <C>
INSURANCE -- 9.31%*
792,900 American Heritage Life Investment Corporation(1)(2)......... $ 25,174,575
135,000 The Guarantee Life Companies Inc.(2)........................ 4,125,937
511,900 Orion Capital Corporation(1)(2)............................. 24,251,263
------------
53,551,775
------------
LEISURE & RECREATIONAL PRODUCTS -- 0.14%*
87,200 The Coleman Company, Inc.**(1).............................. 833,850
------------
MARKET RESEARCH -- 7.56%*
175,600 Abacus Direct Corporation**(1).............................. 21,401,250
594,600 Nielsen Media Research, Inc.(1)(2).......................... 22,111,688
------------
43,512,938
------------
MEDICAL PRODUCTS & SERVICES -- 0.78%*
127,900 OEC Medical Systems, Inc.**(2).............................. 4,492,487
------------
NETWORKING PRODUCTS -- 4.49%*
474,900 International Network Services**(2)......................... 25,822,688
------------
OFFICE FURNITURE -- 2.40%*
513,000 Knoll, Inc.**(1)............................................ 13,786,875
------------
OFFICE PRODUCTS -- 2.85%*
1,742,000 Corporate Express, Inc.**(1)(2)............................. 16,385,687
------------
OIL & GAS EXPLORATION -- 1.38%*
899,000 Poco Petroleums Ltd.**(2)(5)................................ 7,922,457
------------
PAPER & FOREST PRODUCTS -- 3.03%*
1,110,500 MacMillan Bloedel Limited(1)................................ 17,420,969
------------
PHARMACEUTICALS -- 8.89%*
549,200 ALZA Corporation**(2)....................................... 23,512,625
359,500 Centocor, Inc.**(1)......................................... 21,053,219
217,000 Roberts Pharmaceutical Corporation**(2)..................... 6,564,250
------------
51,130,094
------------
PUBLISHING & TRADE SHOWS -- 0.73%*
260,000 Ziff-Davis Inc.**(4)........................................ 4,192,500
------------
REAL ESTATE INVESTMENT TRUSTS -- 0.24%*
63,300 Walden Residential Properties, Inc.(2)...................... 1,380,731
------------
SAVINGS & LOANS -- 0.62%*
402,700 Coast Federal Litigation Contingent Payment Rights
Trust**(7)................................................ 415,284
111,200 First Liberty Financial Corp.(1)............................ 3,141,400
------------
3,556,684
------------
</TABLE>
See notes to the financial statements.
7
<PAGE> 8
THE MERGER FUND
SCHEDULE OF INVESTMENTS (CONTINUED)
SEPTEMBER 30, 1999
<TABLE>
<CAPTION>
SHARES VALUE
------ ------------
<C> <S> <C>
SPECIALTY CHEMICALS -- 6.70%*
493,500 Nalco Chemical Company(2)................................... $ 24,921,750
240,400 Union Carbide Corporation(2)................................ 13,657,725
------------
38,579,475
------------
TV SYNDICATION -- 3.49%*
535,900 King World Productions, Inc.**(1)(2)........................ 20,096,250
------------
TELECOMMUNICATIONS -- 13.45%*
220,900 BCE Mobile Communications Inc.**(2)......................... 8,766,969
763,727 Global Crossing Ltd.**(2)................................... 20,238,766
312,900 Omnipoint Corporation**(4).................................. 17,483,287
916,000 SkyTel Communications, Inc.**(1)............................ 16,774,250
248,000 US WEST, Inc.(4)............................................ 14,151,500
------------
77,414,772
------------
TELECOMMUNICATIONS EQUIPMENT -- 2.87%*
343,500 General Instrument Corporation**............................ 16,530,938
------------
TOTAL COMMON STOCKS (Cost $656,326,320)..................... 648,888,196
------------
CONTRACTS (100 SHARES PER CONTRACT)
- -----------------------------------
PUT OPTIONS PURCHASED -- 7.50%*
AT&T Corp.
4,281 Expiration October 21, 1999, Exercise Price $65.00(6)(8).... 9,204,150
AT&T Corp.
2,095 Expiration January 2000, Exercise Price $50.00.............. 1,597,438
The Dow Chemical Company
1,292 Expiration October 20, 1999, Exercise Price $165.00(6)(8)... 6,637,650
Global Crossing Ltd.
822 Expiration October 1999, Exercise Price $35.00(6)........... 708,975
Global Crossing Ltd.
3,760 Expiration October 1999, Exercise Price $50.00.............. 9,024,000
Global Crossing Ltd.
1,400 Expiration October 1999, Exercise Price $55.00.............. 3,998,750
Motorola, Inc.
1,530 Expiration October 29, 1999, Exercise Price $120.00(6)(8)... 4,896,000
Texas Instruments Incorporated
4,038 Expiration October 1999, Exercise Price $67.50.............. 151,425
Weyerhaeuser Company
3,110 Expiration October 20, 1999, Exercise Price $80.00(6)(8).... 6,958,625
------------
TOTAL PUT OPTIONS PURCHASED
(Cost $43,390,449)........................................ 43,177,013
------------
</TABLE>
See notes to the financial statements.
8
<PAGE> 9
THE MERGER FUND
SCHEDULE OF INVESTMENTS (CONTINUED)
SEPTEMBER 30, 1999
<TABLE>
<CAPTION>
PRINCIPAL AMOUNT VALUE
---------------- ------------
<C> <S> <C>
CONVERTIBLE BONDS -- 0.48%*
$ 2,950,000 MindSpring Enterprises, 5.000%, 4/15/2006
(Cost $2,746,125)......................................... $ 2,747,187
------------
CORPORATE BONDS -- 1.87%*
$10,000,000 CEX Holdings Inc., CLB, 9.625%, 6/01/2008(3)(6)
(Cost $10,162,500)........................................ 10,750,000
------------
VARIABLE RATE DEMAND NOTES# -- 0.00%*
$ 22,703 Warner-Lambert Co., 5.0230%
(Cost $22,703)............................................ 22,703
------------
TOTAL INVESTMENTS
(Cost $712,648,097)....................................... $705,585,099
============
</TABLE>
- ------------------------------
* Calculated as a percentage of net assets.
** Non-income producing security.
# Variable rate demand notes are considered short-term obligations and are
payable on demand. Interest rates change periodically on specified dates.
The rates listed above are as of September 30, 1999.
CLB -- Callable
(1) All or a portion of the shares have been committed as collateral for open
short positions.
(2) All or a portion of the shares have been committed as collateral for the
credit facility.
(3) All or a portion of the shares have been committed as collateral for short
foreign currency contracts.
(4) All or a portion of the shares have been committed as collateral for
written option contracts.
(5) Foreign security.
(6) Fair-valued security.
(7) Litigation settlement rights.
(8) Custom derivative.
See notes to the financial statements.
9
<PAGE> 10
THE MERGER FUND
SCHEDULE OF SECURITIES SOLD SHORT
SEPTEMBER 30, 1999
<TABLE>
<CAPTION>
SHARES VALUE
- ------ ------------
<C> <S> <C>
659,000 Abbott Laboratories......................................... $ 24,218,250
209,200 Adelphia Communications Corporation -- Class A.............. 12,303,575
125,975 AlliedSignal, Inc. ......................................... 7,550,627
20 AT&T Corp. ................................................. 870
94,300 BB&T Corporation............................................ 3,052,963
224,750 Burlington Resources Inc. .................................. 8,259,562
434,103 CBS Corporation............................................. 20,077,264
184,400 DoubleClick Inc. ........................................... 21,966,650
202,950 E.I. du Pont de Nemours and Company......................... 12,354,581
45,425 EMC Corporation............................................. 3,245,048
289,619 First Union Corporation..................................... 10,299,576
165,452 Global Crossing Ltd. ....................................... 4,384,478
38,100 Illinois Tool Works Inc. ................................... 2,840,831
184,650 Infinity Broadcasting Corporation -- Class A................ 5,412,553
215,700 Johnson & Johnson........................................... 19,817,437
402,450 Lucent Technologies Inc. ................................... 26,108,944
235,000 MCI WorldCom, Inc. ......................................... 16,890,625
44,600 Motorola, Inc. ............................................. 3,924,800
116,550 Quebecor Printing Inc. ..................................... 2,673,366
187,900 Qwest Communications International Inc. .................... 5,554,794
173,600 Shire Pharmaceuticals Group PLC -- ADR...................... 5,001,850
49,500 Sunbeam Corporation......................................... 281,531
352,300 Texas Instruments Incorporated.............................. 28,976,675
7,200 Tyco International Ltd. .................................... 743,400
257,423 VoiceStream Wireless Corporation............................ 15,887,826
------------
TOTAL SECURITIES SOLD SHORT
(Proceeds $259,098,409)................................... $261,828,076
============
</TABLE>
See notes to the financial statements.
10
<PAGE> 11
THE MERGER FUND
SCHEDULE OF OPTIONS WRITTEN
SEPTEMBER 30, 1999
<TABLE>
<CAPTION>
CONTRACTS (100 SHARES PER CONTRACT) VALUE
- ----------------------------------- ----------
<C> <S> <C>
CALL OPTIONS
Case Corporation
500 Expiration October 1999, Exercise Price $45.00.............. $ 275,000
US WEST, Inc.
500 Expiration October 1999, Exercise Price $50.00(1)........... 353,125
Ziff-Davis Inc.
450 Expiration October 1999, Exercise Price $15.00.............. 64,687
PUT OPTIONS
AT&T Corp.
2,095 Expiration January 2000, Exercise Price $55.00(1)........... 2,474,719
Texas Instruments Incorporated
3,518 Expiration October 1999, Exercise Price $77.50.............. 571,675
----------
TOTAL OPTIONS WRITTEN
(Premiums received $5,717,202).............................. $3,739,206
==========
</TABLE>
- ------------------------------
(1) Fair-valued security.
See notes to the financial statements.
11
<PAGE> 12
THE MERGER FUND
STATEMENT OF ASSETS AND LIABILITIES
SEPTEMBER 30, 1999
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (Cost $712,648,097)................. $ 705,585,099
Cash...................................................... 17,820,463
Deposit at brokers for short sales........................ 29,422,654
Receivable from brokers for proceeds on securities sold
short.................................................. 264,472,309
Receivable for investments sold........................... 30,486,094
Receivable for fund shares issued......................... 1,667,739
Dividends and interest receivable......................... 1,041,771
Other receivables......................................... 398,522
--------------
Total Assets...................................... 1,050,894,651
--------------
LIABILITIES:
Loan payable (Note 10).................................... $162,600,000
Securities sold short, at value (Proceeds of
$259,098,409).......................................... 261,828,076
Payable for investment securities purchased............... 39,568,750
Options written, at value (Premiums received
$5,717,202)............................................ 3,739,206
Payable for fund shares redeemed.......................... 5,633,098
Accrued interest payable.................................. 808,555
Investment advisory fee payable........................... 508,183
Distribution fees payable................................. 171,523
Payable for forward currency exchange contracts........... 190,679
Dividends payable on short positions...................... 145,768
Accrued expenses and other payables....................... 251,426
------------
Total Liabilities................................. 475,445,264
--------------
NET ASSETS.................................................. $ 575,449,387
==============
NET ASSETS Consist Of:
Accumulated undistributed net investment income........... $ 510,322
Accumulated undistributed net realized gain on investments
sold, securities sold short and option contracts
expired or closed...................................... 32,897,016
Net unrealized appreciation (depreciation) on:
Investments and foreign currency related items......... (7,062,998)
Short positions........................................ (2,729,667)
Written options........................................ 1,977,996
Forward currency exchange contracts.................... (190,679)
Paid-in capital........................................... 550,047,397
--------------
Total Net Assets.................................. $ 575,449,387
==============
NET ASSET VALUE, offering price and redemption price per
share ($575,449,387/37,451,606 shares of beneficial
interest outstanding)..................................... $15.37
======
</TABLE>
See notes to the financial statements.
12
<PAGE> 13
THE MERGER FUND
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED SEPTEMBER 30, 1999
<TABLE>
<S> <C> <C>
INVESTMENT INCOME:
Interest.................................................. $ 8,924,807
Dividend income on long positions
(net of foreign withholding taxes of $59,514).......... 4,691,108
------------
Total investment income................................ 13,615,915
------------
EXPENSES:
Investment advisory fee................................... $ 4,549,174
Distribution fees......................................... 842,509
Transfer agent and shareholder servicing agent fees....... 182,326
Federal and state registration fees....................... 93,827
Professional fees......................................... 140,652
Trustees' fees and expenses............................... 26,038
Custody fees.............................................. 130,227
Administration fee........................................ 204,099
Reports to shareholders................................... 83,242
Other..................................................... 26,775
------------
Total operating expenses before interest expense and
dividends on short positions......................... 6,278,869
Interest expense.......................................... 3,270,434
Dividends on short positions (net of foreign withholding
taxes of $63,620)...................................... 1,593,290
------------
Total expenses......................................... 11,142,593
------------
NET INVESTMENT INCOME....................................... 2,473,322
------------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Realized gain (loss) on:
Long transactions and foreign currency related items... 77,426,883
Short transactions..................................... (4,876,044)
Option contracts expired or closed..................... (16,447,554)
Forward currency exchange contracts.................... (1,871,689)
------------
Net realized gain...................................... 54,231,596
Change in unrealized appreciation (depreciation) on:
Investments and foreign currency related items......... 48,846,717
Short positions........................................ (27,470,052)
Written options........................................ 2,000,221
Forward currency exchange contracts.................... 868,869
------------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS............. 78,477,351
------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $ 80,950,673
============
</TABLE>
See notes to the financial statements.
13
<PAGE> 14
THE MERGER FUND
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED SEPTEMBER 30, 1999
<TABLE>
<S> <C> <C>
CASH PROVIDED (USED) BY FINANCING ACTIVITIES:
Sales of Capital Shares..................................... $ 500,045,668
Repurchases of Capital Shares............................... (429,706,431)
Net Change in Receivables/Payables Related to Capital Share
Transactions.............................................. 3,965,359
---------------
Cash Provided by Capital Share Transactions................. 74,304,596
Cash Provided by Borrowings................................. 51,932,407
Distributions Paid in Cash*................................. (2,232,887)
---------------
$ 124,004,116
-------------
CASH PROVIDED (USED) BY OPERATIONS:
Purchases of Investments.................................... (3,379,458,695)
Proceeds from Sales of Investments.......................... 3,283,325,689
---------------
(96,133,006)
---------------
Increase in Deposit at Brokers for Short Sales.............. (11,938,685)
Net Investment Income....................................... 2,473,322
Net Change in Receivables/Payables Related to Operations.... (585,284)
---------------
(10,050,647)
---------------
(106,183,653)
-------------
Net Increase in Cash........................................ 17,820,463
Cash, Beginning of Year..................................... 0
-------------
Cash, End of Year........................................... $ 17,820,463
=============
</TABLE>
- ------------------------------
*Non-cash financing activities include reinvestment of dividends of $28,405,531.
See notes to the financial statements.
14
<PAGE> 15
THE MERGER FUND
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
SEPTEMBER 30, 1999 SEPTEMBER 30, 1998
------------------ ------------------
<S> <C> <C>
Net investment income.................................... $ 2,473,322 $ 6,433,162
Net realized gain on investments sold, forward currency
exchange contracts, securities sold short and option
contracts expired or closed............................ 54,231,596 32,750,166
Change in unrealized appreciation (depreciation) of
investments, forward currency exchange contracts, short
positions and written options.......................... 24,245,755 (35,986,058)
------------ ------------
Net increase in net assets resulting from operations..... 80,950,673 3,197,270
------------ ------------
Distributions to shareholders from:
Net investment income.................................. (5,109,498) (813,613)
Net realized gains..................................... (25,528,920) (44,190,435)
------------ ------------
Total dividends and distributions...................... (30,638,418) (45,004,048)
------------ ------------
Net increase in net assets from capital share
transactions (Note 6).................................. 98,744,768 22,212,257
------------ ------------
Net increase (decrease) in net assets.................... 149,057,023 (19,594,521)
NET ASSETS:
Beginning of period...................................... 426,392,364 445,986,885
------------ ------------
End of period (including accumulated undistributed net
investment income of $510,322 and $5,458,760,
respectively).......................................... $575,449,387 $426,392,364
============ ============
</TABLE>
See notes to the financial statements.
15
<PAGE> 16
THE MERGER FUND
FINANCIAL HIGHLIGHTS
Selected per share data is based on a share of beneficial interest outstanding
throughout each period.
<TABLE>
<CAPTION>
YEAR YEAR TEN MONTHS YEAR ENDED
ENDED ENDED ENDED NOVEMBER 30,
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, ----------------------
1999 1998 1997(7) 1996 1995
------------- ------------- ------------- -------- --------
<S> <C> <C> <C> <C> <C>
Net Asset Value, beginning of
period............................... $13.90 $15.35 $15.41 $14.87 $13.72
Income from investment operations:
Net investment income.............. 0.08(2)(3) 0.20(2)(3) 0.02(2)(3) 0.20(2)(3) 0.08(2)(3)
Net realized and unrealized gain
(loss) on investments............ 2.71 (0.05) 1.35 1.24 1.78
-------- -------- -------- -------- --------
Total from investment operations... 2.79 0.15 1.37 1.44 1.86
Less distributions:
Dividends from net investment
income........................... (0.22) (0.03) (0.19) (0.08) --
Distributions from net realized
gains............................ (1.10) (1.57) (1.24) (0.82) (0.71)
-------- -------- -------- -------- --------
Total distributions................ (1.32) (1.60) (1.43) (0.90) (0.71)
-------- -------- -------- -------- --------
Net Asset Value, end of period....... $15.37 $13.90 $15.35 $15.41 $14.87
======== ======== ======== ======== ========
Total Return......................... 21.39% 0.82% 9.68%(5) 10.26% 14.26%
Supplemental Data and Ratios:
Net assets, end of period
(000's).......................... $575,449 $426,392 $445,987 $489,084 $243,082
Ratio of operating expenses to
average net assets............... 1.38%(1) 1.33%(1) 1.36%(1)(6) 1.36%(1) 1.41%(1)
Ratio of interest expense and
dividends on short positions to
average net assets............... 1.07% 1.93% 2.93%(6) 0.95% 2.42%
Ratio of net investment income to
average net assets............... 0.54% 1.36% 0.13%(6) 1.36% 0.57%
Portfolio turnover rate(4)......... 386.52% 355.38% 271.24% 276.99% 290.48%
</TABLE>
- ------------------------------
(1) For the years ended September 30, 1999 and 1998, the ten months ended
September 30, 1997, and for the years ended November 30, 1996 and 1995, the
operating expense ratio excludes interest expense and dividends on short
positions. The ratios including interest expense and dividends on short
positions for the years ended September 30, 1999 and 1998, the ten months
ended September 30, 1997, and for the years ended November 30, 1996 and
1995, were 2.45%, 3.26 %, 4.29%, 2.31% and 3.83%, respectively.
(2) Net investment income before interest expense and dividends on short
positions for the years ended September 30, 1999 and 1998, the ten months
ended September 30, 1997, and for the years ended November 30, 1996 and
1995, was $0.23, $0.49, $0.38, $0.35 and $0.42, respectively.
(3) 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) The numerator for the portfolio turnover rate includes the lesser of
purchases or sales (excluding short positions). The denominator includes the
average long position throughout the period.
(5) Not annualized.
(6) Annualized.
(7) Effective December 1, 1996 the Fund's fiscal year end was changed to
September 30 from November 30.
See notes to the financial statements.
16
<PAGE> 17
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
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 (the "1940 Act"), as amended. 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
Investments in securities and commodities (including options) are valued at
the last sales price on the securities or commodities exchange on which such
financial instruments are primarily traded. Securities not listed on an exchange
or securities for which there were no transactions are valued at the average of
the current bid and asked prices. 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. At September 30, 1999 fair
valued long securities represent 5.6% of investments, at value, while fair
valued written options represent 75.6% of options written, at value. The
investment adviser reserves the right to value securities, including options, at
prices other than last-sale prices or the average of current bid and asked
prices when such prices are believed unrepresentative of fair market value as
determined in good faith by the adviser. 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. Transactions with Brokers for Short Sales
Cash and liquid securities in the amount of $267,903,832 have been
committed as collateral for open short investment positions and specifically
identified in the Fund's records. 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.
17
<PAGE> 18
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1999
NOTE 2 -- SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
C. 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.
D. 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 last sales price
reported on the date of valuation. If no sale is reported, the option contract
written is 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), and the Fund realizes a gain or loss from the sale of the
underlying security.
E. 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 last sales price reported on the date of valuation. If no sale is reported,
the option contract purchased is valued at the average of the current bid and
asked price reported 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.
F. 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.
18
<PAGE> 19
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1999
NOTE 2 -- SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
G. 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 and straddle loss deferrals and unrealized gains or losses on Section
1256 contracts, which are realized, for tax purposes, at September 30, 1999. The
Fund also utilized earnings and profits distributed to shareholders on
redemption of shares as part of the dividends paid deduction. 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.
H. 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.
I. Foreign Securities
Investing in securities of foreign companies and foreign governments
involves special risks and considerations not typically associated with
investing in U.S. companies and the U.S. government. These risks include
revaluation of currencies and future adverse political and economic
developments. Moreover, securities of many foreign companies and foreign
governments and their markets may be less liquid and their prices more volatile
than those of securities of comparable U.S. companies and the U.S. government.
J. 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.
19
<PAGE> 20
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1999
NOTE 2 -- SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
K. 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.
L. 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 $8,081,959 of interest earned on receivables
from brokers for proceeds on securities sold short and deposits. The Fund may
utilize derivative instruments including options, forward currency exchange
contracts and other instruments with similar characteristics to the extent that
they are consistent with the Fund's investment objectives and limitations. The
use of these instruments may involve additional investment risks including the
possibility of illiquid markets or imperfect correlation between the value of
the instruments and the underlying securities.
NOTE 3 -- AGREEMENTS
The Fund's investment adviser is Westchester Capital Management, Inc. (the
"Adviser") pursuant to an investment advisory agreement dated 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.
Firstar Mutual Fund Services, LLC, a subsidiary of Firstar Corporation, a
publicly held bank holding company, serves as transfer agent, administrator and
accounting services agent for the Fund. Firstar Bank Milwaukee, N.A. serves as
custodian for the Fund.
Distribution services are performed pursuant to distribution contracts with
Mercer Allied Company, L.P. ("Mercer"), the Fund's principal underwriter, and
other broker-dealers.
NOTE 4 -- SHORT POSITIONS
The Fund may sell securities 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 sold,
20
<PAGE> 21
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1999
NOTE 4 -- SHORT POSITIONS (CONTINUED)
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. These assets are required to be adjusted
daily to reflect changes in the value of the securities sold short.
NOTE 5 -- RELATED PARTY TRANSACTIONS
William H. Bohnett, Esq., a partner of Fulbright & Jaworski L.L.P., served
as a Trustee and Assistant Secretary of the Fund during the year ended September
30, 1999. Fulbright & Jaworski L.L.P. furnishes legal services to the Fund. For
the year ended September 30, 1999 the Fund paid $94,602 for such services.
Certain officers of the Fund are also officers of the Adviser.
NOTE 6 -- 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:
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
SEPTEMBER 30, 1999 SEPTEMBER 30, 1998
----------------------------- -----------------------------
SHARES AMOUNT SHARES AMOUNT
------------ -------------- ------------ --------------
<S> <C> <C> <C> <C>
Sold........................ 34,234,589 $ 500,045,668 14,330,739 $ 208,258,666
Issued as reinvestment of
dividends................. 2,104,113 28,405,531 3,071,709 43,453,261
Redeemed.................... (29,554,687) (429,706,431) (15,780,835) (229,499,670)
----------- ------------- ----------- -------------
Net increase................ 6,784,015 $ 98,744,768 1,621,613 $ 22,212,257
=========== ============= =========== =============
</TABLE>
From October 1, 1998 through October 13, 1998 and from August 9, 1999
through September 30, 1999, The Merger Fund was closed to new investors.
NOTE 7 -- INVESTMENT TRANSACTIONS
Purchases and sales of securities for the year ended September 30, 1999
(excluding short-term investments, options and short positions) aggregated
$2,020,437,260 and $1,901,158,478, respectively.
21
<PAGE> 22
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1999
NOTE 7 -- INVESTMENT TRANSACTIONS (CONTINUED)
At September 30, 1999, gross unrealized appreciation and depreciation of
investments for federal income tax purposes were:
<TABLE>
<S> <C>
Appreciation................................................ $ 27,954,637
(Depreciation).............................................. (35,410,361)
------------
Net unrealized depreciation on investments.................. $ (7,455,724)
============
</TABLE>
At September 30, 1999, the cost of investments for federal income tax
purposes was $713,040,823. The primary difference between the cost amount for
book purposes and tax purposes is due to deferred wash sale losses. The Fund
realized, on a tax basis, post-October losses through September 30, 1999 of
$6,585,077 which are not recognized for tax purposes until the first day of the
following fiscal year.
NOTE 8 -- OPTION CONTRACTS WRITTEN
The premium amount and the number of option contracts written during the
year ended September 30, 1999, were as follows:
<TABLE>
<CAPTION>
PREMIUM NUMBER OF
AMOUNT CONTRACTS
------------ ---------
<S> <C> <C>
Options outstanding at September 30, 1998.................. $ 1,632,021 10,359
Options written............................................ 33,994,714 66,547
Options closed............................................. (16,110,482) (32,765)
Options exercised.......................................... (9,801,589) (23,884)
Options expired............................................ (3,997,462) (13,194)
------------ -------
Options outstanding at September 30, 1999.................. $ 5,717,202 7,063
============ =======
</TABLE>
NOTE 9 -- DISTRIBUTION PLAN
The Fund has adopted a Plan of Distribution (the "Plan") dated July 1,
1993, as amended, pursuant to Rule 12b-1 under the 1940 Act. Under the Plan, the
Fund will compensate its principal underwriter, Mercer, and any other
broker-dealers with whom Mercer or 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 record keeping, subaccounting, subtransfer agency and/or shareholder
liaison services. For the year ended September 30, 1999, the Fund incurred
$842,509 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.
22
<PAGE> 23
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1999
NOTE 10 -- CREDIT FACILITY
Custodial Trust Company has made available to the Fund a $230 million
credit facility 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, 1998 to
July 31, 1999, the interest rate on the outstanding principal amount was the
Federal Funds Rate plus 1.00%. The interest rate changed on August 1, 1999 to
the Federal Funds Rate plus 0.875% (weighted average rate of 5.96% during the
year ended September 30, 1999). 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 year ended September
30, 1999, the Fund had an outstanding average daily balance of $59,428,721. The
maximum amount outstanding during the year ended September 30, 1999, was
$206,312,000. Cash paid for interest amounted to $3,319,263 for the year ended
September 30, 1999. At September 30, 1999, the Fund had a loan payable balance
of $162,600,000 and the securities collateralizing the Agreement amounted to
$327,116,504.
NOTE 11 -- FORWARD CURRENCY EXCHANGE CONTRACTS
At September 30, 1999, the Fund had entered into a "position hedge" forward
currency exchange contract that obligated the Fund to deliver and receive a
currency at a specified future date. The net unrealized depreciation of $190,679
is included in the net unrealized appreciation (depreciation) section of the
accompanying financial statements. The terms of the open contract are as
follows:
<TABLE>
<CAPTION>
CURRENCY TO U.S. $ VALUE AT CURRENCY TO U.S. $ VALUE AT
SETTLEMENT DATE BE DELIVERED SEPTEMBER 30, 1999 BE RECEIVED SEPTEMBER 30, 1999
- --------------- ------------ ------------------ ----------- ------------------
<S> <C> <C> <C> <C>
10/15/99 12,977,875 Canadian Dollars $8,835,680 8,645,001 U.S. Dollars $8,645,001
</TABLE>
23
<PAGE> 24
INCOME TAX INFORMATION
The Fund hereby designates the following amounts as long-term capital gain
distributions for purposes of the dividends paid deduction.
<TABLE>
<S> <C>
Capital Gains Taxed at 20%.................................. $1,544,301
</TABLE>
24
<PAGE> 25
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Trustees and Shareholders
of The Merger Fund
In our opinion, the accompanying statement of assets and liabilities,
including the schedules of investments, of options written and of securities
sold short, and the related statements of operations, of cash flows and of
changes in net assets and the financial highlights present fairly, in all
material respects, the financial position of The Merger Fund (the "Fund") at
September 30, 1999, the results of its operations, the results of its cash
flows, the changes in its net assets and the financial highlights for each of
the periods indicated, in conformity with generally accepted accounting
principles. These financial statements and financial highlights (hereafter
referred to as "financial statements") are the responsibility of the Fund's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these financial
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits, which included
confirmation of securities at September 30, 1999 by correspondence with the
custodian and brokers, and the application of alternative auditing procedures
where broker confirmations were not received, provide a reasonable basis for the
opinion expressed above.
/s/ PricewaterhouseCoopers LLP
Milwaukee, Wisconsin
November 12, 1999
25
<PAGE> 26
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
Firstar Mutual Fund Services, LLC
615 East Michigan Street
P.O. Box 701
Milwaukee, WI 53201-0701
(800) 343-8959
CUSTODIAN
Firstar Bank Milwaukee, N.A.
P.O. Box 701
Milwaukee, WI 53201-0701
(800) 343-8959
TRUSTEES
Frederick W. Green
William H. Bohnett
Michael J. Downey
James P. Logan III
EXECUTIVE OFFICERS
Frederick W. Green, President
Bonnie L. Smith, Vice President, Treasurer
and Secretary
COUNSEL
Fulbright & Jaworski L.L.P.
666 Fifth Avenue
New York, NY 10103
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP
100 East Wisconsin Avenue
Milwaukee, WI 53202
[THE MERGER FUND LOGO]
ANNUAL REPORT
SEPTEMBER 30, 1999
