<PAGE> 1
November 13, 2000
Dear Fellow Shareholder:
Fiscal 2000 was another strong year for The Merger Fund(R). As previously
reported, the Fund showed a gain of 19.1% in the 12 months ended September 30,
substantially exceeding our rate-of-return targets. The Fund's above-trendline
performance was again attributable to an abundance of mergers and takeovers,
attractive arbitrage spreads -- especially for deals with "wrinkles" -- and a
selective investment approach that enabled us to avoid a number of failed
transactions. Out of more than 150 arbitrage positions held by The Merger
Fund(R) during fiscal 2000, just three deals were not completed. Not only did
the Fund post strong absolute gains, but our risk profile also remained
unsurpassed in the industry. Based on Morningstar data for the three years ended
September 30, The Merger Fund(R) can claim the most consistent monthly returns,
the most favorable Morningstar risk rating and the 10th lowest sensitivity to
market fluctuations out of approximately 3,000 equity mutual funds. Fiscal 2000
represented the third consecutive year in which the Fund ranked number one in
the first two categories and among the top 10 in the third. The Merger Fund(R)
also carries the highest Sharpe ratio -- a measure of risk-adjusted
performance -- in the Morningstar universe.
As is customary in these annual reports, we have included a series of pie
charts which reflect the nature of the arbitrage opportunities in which the Fund
has recently invested. Chart 1 indicates that as of September 30, friendly
transactions represented 100% of our holdings. Although we have no problem
investing in unsolicited, or hostile, takeover attempts, such deals continue to
represent a small percentage of M&A activity. That's because nothing much has
changed in recent years to improve the generally poor odds facing unwelcome
suitors. The stars must be in perfect alignment for a hostile takeover to work.
Judicial rulings have validated the "just-say-no" defense backed up by a poison
pill, and staggered boards, restricted voting rights and other limitations on
corporate democracy make it difficult to gain control of the target's board by
waging a proxy contest. Even when a would-be acquirer is able to penetrate the
target's takeover defenses, a white knight often ends up snatching away the
prize. Unsolicited offers may have a better chance of success when the target
has already agreed to another business combination, a situation in which the
"just-say-no" defense would not be effective. For example, it was relatively
easy for General Electric to win control of Honeywell with a superior bid after
word leaked out that Honeywell was close to finalizing an agreement to be
acquired by United Technologies. Even if Honeywell's management had preferred to
do a deal with the company's original suitor, a stock-for-stock acquisition by
United Technologies would have required the approval of Honeywell's
shareholders, who presumably would not have been supportive in the face of a
better offer from one of the world's most admired corporations.
Chart 2 shows that virtually all of the acquisitions in which the Fund has
recently invested are strategic in nature, meaning deals that involve a
corporate buyer -- usually operating in the same industry as the target -- whose
management sees the transaction as a faster and more cost-effective alternative
to building the business organically. To understand why highly leveraged,
financially driven takeovers of public companies remain relatively infrequent,
it is helpful to consider the prerequisites for a successful LBO. For starters,
the target's private market value must exceed its public market value. Stated
another way, the company should be substantially undervalued relative to what it
would be worth to a financial buyer intent on dressing it up for a sale or IPO a
few years down the road. Cash flows should be predictable and not wholly
encumbered by capital-spending requirements, so that the buyout group can pay
down debt relatively quickly. And existing management must be willing to
participate in the going-private transaction. Although many corporate executives
probably would like to
<PAGE> 2
free themselves from the hassles of public ownership, in recent years few of
their companies have been cheap enough to attract the interest of LBO firms.
Long-running bull markets do not make for great bargains on Wall Street. Even
assuming that a suitable LBO candidate can be found, however, another challenge
is to secure financing for the transaction, and the debt markets have not been
friendly to highly leveraged deals for most of this year. Finally, financial
buyers may end up bidding against strategic players with deeper pockets and the
ability to realize greater synergies from the combination. From an arbitrageur's
perspective, of course, the continued paucity of LBOs is not such a bad thing.
Committed corporate buyers willing to take the long view are clearly preferable
to short-term-oriented financial players, whose deals tend to be more
accident-prone. An example of the latter is the failed buyout of Westpoint
Stevens earlier this year, a transaction in which the Fund had made a small
investment. Although this LBO appeared to be eminently financeable thanks to a
large infusion of equity, the buyout collapsed when an uptick in interest rates
changed the economics of the deal for the investor group.
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. About 68% of our deals, measured as a percentage of the Fund's long
positions, involve at least some stock, down slightly from a year earlier. If
foreign acquisitions of U.S. companies are excluded, however, the percentage of
stock deals rises to almost 86%. In addition to taking advantage of what are
still generous equity valuations, stock-for-stock transactions permit
pooling-of-interests accounting treatment, an approach that allows the buyer to
avoid earnings dilution tied to the amortization of goodwill. In last year's
annual report, we discussed the prospective elimination of pooling as of January
1, 2001, and suggested that owing to the increasing focus on "cash"
earnings -- which exclude goodwill charges -- M&A activity would not drop off a
cliff if the Financial Accounting Standards Board officially implemented its
draft proposal. It turns out that under pressure from Corporate America, the
FASB has decided to extend its review of this issue, with a final decision not
expected until sometime next year. We still expect that all mergers and
takeovers will eventually have to be done under purchase accounting, but it now
also seems likely that the FASB will come up with an approach to the
amortization of goodwill that will lessen the impact on reported earnings.
Chart 4 shows our investments grouped by economic sector. As has been the
case each year since the Fund's inception in 1989, the financial services
category, which includes banks, brokers, insurers and investment companies,
represents the largest segment of our portfolio (28%). Despite the consolidation
that has already taken place in this sector over the past decade, the financial
services market remains relatively fragmented, and foreign companies in
particular show no sign of losing their appetite for acquisitions in the U.S.
Ranking second in the Fund's portfolio are media deals (14%). Radio and TV
broadcasters are doing acquisitions because in their industry scale is viewed as
an important strategic asset, while the presumed benefits of combining content
with distribution are driving other deals in this sector. Mergers and takeovers
involving technology companies represent about 12% of our investments. As might
be expected in such a dynamic area of the economy, the managements of these
firms often conclude that the best way to stay ahead of the curve is to acquire
someone else's cutting-edge technology. In the last year or so, for example,
manufacturers of networking equipment have been on a buying binge in an attempt
to fill gaps in their product lines. Telecom deals, which a year earlier
represented 16% of our holdings, now account for just 7%. Limiting M&A activity
in this sector are regulatory obstacles and the fact that many would-be
acquirers have seen their stocks trashed in recent months. Total merger volume
in the U.S. has remained at near-
2
<PAGE> 3
record levels, and a moderate slowdown in deal-making would not be surprising.
Investing in the right transactions, however, has always had a greater impact on
our results than the quantity of arbitrage opportunities. We'll try to keep our
batting average high in the year ahead.
Fiscal 2000 saw the net assets of The Merger Fund(R) cross the $1 billion
mark. Not bad for an investment vehicle that has been closed to new investors
for 15 months! We appreciate the support of our shareholders, and we are
confident that the Fund can continue to deliver what it has become known for
over the past 12 years: solid risk-adjusted performance in good markets and bad.
Sincerely,
/s/ Frederick W. Green
Frederick W. Green
President
Note: The performance figures discussed in this letter 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.
3
<PAGE> 4
THE MERGER FUND(R)
PORTFOLIO COMPOSITION
BY TYPE OF DEAL*
[PIE CHART]
<TABLE>
<CAPTION>
HOSTILE FRIENDLY
------- --------
<S> <C>
0 100
</TABLE>
[PIE CHART]
<TABLE>
<CAPTION>
FINANCIAL STRATEGIC
--------- ---------
<S> <C>
3.2 96.80
</TABLE>
* Data as of 9/30/00
4
<PAGE> 5
THE MERGER FUND(R)
PORTFOLIO COMPOSITION
BY DEAL TERMS*
[PIE CHART]
<TABLE>
<CAPTION>
STOCK WITH FLEXIBLE
STOCK WITH FIXED EXCHANGE RATIO EXCHANGE RATIO CASH & STOCK CASH UNDETERMINED
------------------------------- ------------------- ------------ ---- ------------
<S> <C> <C> <C> <C>
33.3 9.0 25.4 26.9 5.4
</TABLE>
PORTFOLIO COMPOSITION
BY SECTOR*
[PIE CHART]
<TABLE>
<CAPTION>
CONSUMER
CONSUMER BUSINESS FINANCIAL NON- BASIC
SERVICES SERVICES SERVICES MEDIA TECHNOLOGY DURABLES INDUSTRIES TELECOMMUNICATIONS UTILITIES
-------- -------- --------- ----- ---------- -------- ---------- ------------------ ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1.1 0.2 28.4 14.1 12.2 11.5 9.5 7.1 5.0
<CAPTION>
MULTI- CONSUMER
HEALTHCARE SECTOR DURABLES ENERGY
---------- ------ -------- ------
<S> <C> <C> <C>
4.0 3.4 1.8 1.7
</TABLE>
* Data as of 9/30/00
5
<PAGE> 6
COMPARISON OF CHANGE IN VALUE OF $10,000 INVESTMENT
IN THE MERGER FUND AND THE S&P 500
[COMPARISON LINE GRAPH]
<TABLE>
<CAPTION>
S&P500 THE MERGER
FUND
------ ----
<S> <C> <C>
9/90 10000 10000
9958 10312
10602 10814
10897 10938
11372 10988
12185 11019
12480 11342
12509 11655
13049 11726
12451 11907
13032 12130
13340 12200
9/91 13117 12221
13293 12321
12758 12635
14217 12779
13952 12993
14132 12993
13858 13068
14264 13057
14334 12982
14121 12908
14698 13303
14397 13453
9/92 14566 13560
14617 13667
15114 13196
15300 13462
15428 13743
15638 13833
15968 13766
15582 13946
15999 14126
16046 14520
15981 14805
16587 14974
9/93 16460 15076
16801 15301
16641 15471
16842 15848
17414 16031
16941 15970
16202 16007
16409 16178
16679 16288
16270 16435
16804 16594
17493 16875
9/94 17064 16973
17448 16900
16813 16778
17062 16979
17503 17300
18186 17506
18723 17621
19273 17505
20044 17621
20505 17920
21182 18261
21245 18498
9/95 22142 18794
22062 18845
23031 19154
23475 19363
24273 19581
24498 19869
24733 20102
25097 20252
25744 20485
25842 20582
24700 20444
25221 20703
9/96 26641 20896
27377 20896
29446 21115
28863 21288
30667 21425
30906 21425
29636 21530
31405 21499
33318 22028
34811 22361
37581 22571
35477 22977
9/97 37421 23157
36171 23263
37846 23610
38497 23768
38924 23599
41731 23970
43867 23987
44310 24373
43548 24356
45316 24843
44836 24825
38353 23532
9/98 40811 23346
44129 23916
46803 24504
49499 25038
51568 25186
49964 25629
51963 25924
53974 26328
52700 26734
55625 27453
53889 27876
53625 28024
9/99 52156 28318
55457 28612
56583 29405
59916 29370
56908 29807
55833 30347
61293 30844
59448 31322
58229 31601
59668 32138
58737 32598
62384 33175
9/00 59091 33712
</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. 10 YR.
----- ----- ---------------
<S> <C> <C> <C>
The Merger Fund.................................. 19.1% 12.4% 12.9%
</TABLE>
6
<PAGE> 7
THE MERGER FUND
SCHEDULE OF INVESTMENTS
SEPTEMBER 30, 2000
<TABLE>
<CAPTION>
SHARES VALUE
------ --------------
<C> <S> <C>
COMMON STOCKS -- 103.29%*
ADVERTISING -- 3.79%*
825,600 Young & Rubicam Inc......................................... $ 40,867,200
--------------
AUTO RENTAL -- 1.14%*
365,400 Avis Group Holdings, Inc.**(1)(4)........................... 10,824,975
45,600 The Hertz Corporation -- Class A(1)......................... 1,447,800
--------------
12,272,775
--------------
BANKS -- 1.79%*
1,184,700 First Security Corporation(1)............................... 19,325,419
--------------
BROADCASTING -- 5.73%*
221,600 Chris-Craft Industries, Inc.**(1)........................... 18,254,300
1,321,550 Infinity Broadcasting Corporation -- Class A**(1)........... 43,611,150
--------------
61,865,450
--------------
BROKERAGE & INVESTMENT BANKING -- 12.86%*
655,600 Donaldson, Lufkin & Jenrette, Inc.(1)....................... 58,635,225
262,811 J.P. Morgan & Co. Incorporated(1)(4)........................ 42,936,747
545,100 Paine Webber Group Inc.(2)(3)............................... 37,134,937
--------------
138,706,909
--------------
CABLE TV -- 3.68%*
1,336,300 Le Groupe Videotron Itee(6)................................. 39,655,586
--------------
CEMENT & AGGREGATES -- 2.45%*
370,400 Southdown, Inc. ............................................ 26,391,000
--------------
CHEMICALS & COATINGS -- 4.39%*
937,400 Lilly Industries, Inc. -- Class A........................... 27,653,300
521,000 Union Carbide Corporation(5)................................ 19,667,750
--------------
47,321,050
--------------
COMPUTER HARDWARE -- 3.47%*
543,300 Seagate Technology, Inc.**(2)(5)............................ 37,487,700
--------------
CONSUMER FINANCE -- 4.12%*
1,170,700 Associates First Capital Corporation -- Class A(1).......... 44,486,600
--------------
ELECTRIC UTILITIES -- 0.50%*
233,900 IPALCO Enterprises, Inc. ................................... 5,350,463
--------------
ENTERTAINMENT -- 2.00%*
276,300 Time Warner Inc.(5)......................................... 21,620,475
--------------
</TABLE>
See notes to the financial statements.
7
<PAGE> 8
THE MERGER FUND
SCHEDULE OF INVESTMENTS (CONTINUED)
SEPTEMBER 30, 2000
<TABLE>
<CAPTION>
SHARES VALUE
------ --------------
<C> <S> <C>
FOOD -- 12.35%*
816,300 Bestfoods(1)................................................ $ 59,385,825
874,400 Keebler Foods Company(4).................................... 36,724,800
179,400 Nabisco Group Holdings Corp.(3)............................. 5,112,900
596,500 Nabisco Holdings Corp. -- Class A(3)........................ 32,061,875
--------------
133,285,400
--------------
GAS UTILITIES -- 0.36%*
153,300 MCN Energy Group Inc. ...................................... 3,928,312
--------------
GIFTWARE -- 0.03%*
73,554 Syratech Corporation**(7)................................... 367,770
--------------
HOME FURNISHINGS -- 1.96%*
1,141,400 Shaw Industries, Inc.(5).................................... 21,115,900
--------------
INSURANCE & INVESTMENT MANAGEMENT -- 7.27%*
1,052,300 AXA Financial, Inc.(1)(4)................................... 53,601,531
108,275 Axa -- ADR(1)............................................... 7,004,039
454,000 Nvest, L.P.(3).............................................. 17,876,250
--------------
78,481,820
--------------
INTERNET SERVICES -- 2.35%*
368,300 Lycos, Inc.**(4)............................................ 25,326,380
--------------
MEDICAL PRODUCTS & SERVICES -- 3.94%*
932,150 Mallinckrodt Inc.(1)........................................ 42,529,344
--------------
METALS & MINING -- 0.35%*
201,200 Rio Algom Limited(6)(7)..................................... 3,811,113
--------------
MULTI-INDUSTRY -- 3.66%*
449,200 The Seagram Company Ltd.(5)(6).............................. 25,800,925
578,000 United Dominion Industries Limited(5)....................... 13,691,375
--------------
39,492,300
--------------
NATURAL GAS TRANSMISSION & MARKETING -- 4.53%*
688,400 Columbia Energy Group....................................... 48,876,400
--------------
NETWORKING PRODUCTS -- 2.85%*
216,200 Alteon Websystems, Inc.**(1)................................ 23,434,053
23,500 SDL, Inc.**................................................. 7,268,844
--------------
30,702,897
--------------
NETWORKING SOFTWARE -- 4.48%*
340,000 Janna Systems Inc.**(6)..................................... 18,755,816
162,900 Software.com, Inc.**(5)..................................... 29,556,169
--------------
48,311,985
--------------
</TABLE>
See notes to the financial statements.
8
<PAGE> 9
THE MERGER FUND
SCHEDULE OF INVESTMENTS (CONTINUED)
SEPTEMBER 30, 2000
<TABLE>
<CAPTION>
SHARES VALUE
------ --------------
<C> <S> <C>
OILFIELD EQUIPMENT & SERVICES -- 1.81%*
701,800 R&B Falcon Corporation**(2)................................. $ 19,562,675
--------------
PAPER & FOREST PRODUCTS -- 2.43%*
813,850 Fort James Corporation(1)................................... 24,873,291
154,463 Stora Enso Oyj -- Class R(6)................................ 1,293,667
--------------
26,166,958
--------------
PHARMACEUTICALS -- 0.33%*
100,000 Dura Pharmaceuticals, Inc.**(1)............................. 3,537,500
--------------
PROPERTY-CASUALTY INSURANCE -- 0.43%*
119,600 HSB Group, Inc.(1).......................................... 4,798,950
--------------
REAL ESTATE INVESTMENT TRUSTS -- 0.47%*
106,200 Urban Shopping Centers, Inc. ............................... 5,044,500
--------------
TELEPHONY -- 7.77%*
372,307 AT&T Corp.(1)............................................... 10,936,518
60,557 AT&T Wireless Group**(1).................................... 1,264,127
755,033 Clearnet Communications Inc. -- Class A**(1)................ 33,457,400
43,900 Deutsche Telekom AG -- ADR(1)............................... 1,503,575
32,000 Tritel, Inc.**.............................................. 458,000
311,800 VoiceStream Wireless Corporation**.......................... 36,188,287
--------------
83,807,907
--------------
TOTAL COMMON STOCKS (Cost $1,135,056,473)................... 1,114,498,738
--------------
CONTRACTS (100 SHARES PER CONTRACT)
-----------------------------------------------------------------------
PUT OPTIONS PURCHASED -- 2.16%*
Citigroup Inc.
7,500 Expiration October 26, 2000, Exercise Price $85.00(7)..... 23,203,125
Tyco International Ltd.
6,049 Expiration October 2000, Exercise Price $35.00............ 75,612
--------------
TOTAL PUT OPTIONS PURCHASED
(Cost $23,602,190)........................................ 23,278,737
--------------
</TABLE>
See notes to the financial statements.
9
<PAGE> 10
THE MERGER FUND
SCHEDULE OF INVESTMENTS (CONTINUED)
SEPTEMBER 30, 2000
<TABLE>
<CAPTION>
PRINCIPAL AMOUNT VALUE
---------------- --------------
<C> <S> <C>
SHORT-TERM INVESTMENTS -- 0.03%*
VARIABLE RATE DEMAND NOTES# -- 0.03%*
355,371 Firstar Bank, 6.37%......................................... $ 355,371
--------------
TOTAL SHORT-TERM INVESTMENTS
(Cost $355,371)........................................... 355,371
--------------
TOTAL INVESTMENTS
(Cost $1,159,014,034)..................................... $1,138,132,846
==============
</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, 2000.
(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 equity
swap contracts.
(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) All or a portion of the shares have been committed as collateral for the
credit facility.
(6) Foreign security.
(7) Fair-valued security.
See notes to the financial statements.
10
<PAGE> 11
THE MERGER FUND
SCHEDULE OF SECURITIES SOLD SHORT
SEPTEMBER 30, 2000
<TABLE>
<CAPTION>
SHARES VALUE
------ ------------
<C> <S> <C>
191,390 Alcan Aluminum Ltd. ........................................ $ 5,538,348
414,450 America Online, Inc. ....................................... 22,276,688
251,598 AT&T Wireless Group......................................... 5,252,108
214,040 Axa -- ADR.................................................. 13,845,713
67,125 Axa......................................................... 8,767,540
870,000 The Chase Manhattan Corporation............................. 40,183,125
108,540 Citigroup Inc. ............................................. 5,867,944
1,000,720 Deutsche Telekom AG......................................... 34,355,316
40,960 Deutsche Telekom AG -- ADR.................................. 1,402,880
839,727 The Dow Chemical Company.................................... 20,940,692
54,118 DTE Energy Company.......................................... 2,070,013
67,200 Elan Corporation plc -- ADR................................. 3,679,200
214,880 Georgia-Pacific Group....................................... 5,049,680
89,300 JDS Uniphase Corporation.................................... 8,455,594
256,898 The News Corporation Limited -- ADR......................... 12,042,094
291,210 NiSource Inc. .............................................. 7,098,244
395,612 Nortel Networks Corporation................................. 23,563,640
262,240 Phone.com, Inc. ............................................ 29,797,020
169,000 Siebel Systems, Inc. ....................................... 18,811,812
24,300 TeleCorp PCS, Inc. ......................................... 461,700
452,990 TELUS Corporation........................................... 11,771,839
350,900 Transocean Sedco Forex Inc. ................................ 20,571,512
440,900 Tyco International Ltd. .................................... 22,871,687
18,600 UBS AG -- Global Registered Shares.......................... 2,519,184
116,415 UBS AG -- Ordinary Shares................................... 15,767,248
253,706 VERITAS Software Corporation................................ 36,026,252
792,860 Viacom Inc. -- Class B...................................... 46,382,310
264,340 Vivendi SA.................................................. 19,642,951
419,550 Wells Fargo & Company....................................... 19,273,078
1,960,969 WPP Group plc............................................... 23,486,395
------------
TOTAL SECURITIES SOLD SHORT
(Cost $524,827,186) $487,771,807
============
</TABLE>
See notes to the financial statements.
11
<PAGE> 12
THE MERGER FUND
SCHEDULE OF OPTIONS WRITTEN
SEPTEMBER 30, 2000
<TABLE>
<CAPTION>
CONTRACTS (100 SHARES PER CONTRACT) VALUE
----------------------------------- ----------
<C> <S> <C>
CALL OPTIONS
AXA Financial, Inc.
1,621 Expiration October 2000, Exercise Price $50.00.............. $ 253,281
Avis Group Holdings, Inc.
1,065 Expiration October 2000, Exercise Price $30.00.............. 93,187
J.P. Morgan & Co. Incorporated
277 Expiration October 2000, Exercise Price $160.00............. 231,988
Keebler Foods Company:
1,646 Expiration October 2000, Exercise Price $45.00............ 61,725
7,098 Expiration November 2000, Exercise Price $45.00........... 798,525
Lycos, Inc.
3,683 Expiration October 2000, Exercise Price $60.00............ 3,706,019
----------
TOTAL OPTIONS WRITTEN
(Premiums received $8,078,627)............................ $5,144,725
==========
</TABLE>
See notes to the financial statements.
12
<PAGE> 13
THE MERGER FUND
STATEMENT OF ASSETS AND LIABILITIES
SEPTEMBER 30, 2000
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (Cost $1,159,014,034)............... $1,138,132,846
Cash...................................................... 4,575,434
Deposit at brokers for short sales........................ 30,649,405
Receivable from brokers for proceeds on securities sold
short.................................................. 504,970,260
Receivable for investments sold........................... 50,364,951
Receivable for fund shares issued......................... 2,992,592
Receivable for forward currency exchange contracts........ 732,316
Receivable for equity swap contracts...................... 4,065,538
Dividends and interest receivable......................... 2,320,014
Other receivables......................................... 25,592
--------------
Total Assets...................................... 1,738,828,948
--------------
LIABILITIES:
Securities sold short, at value (Proceeds of
$524,827,186).......................................... $487,771,807
Loan payable.............................................. 67,800,000
Payable for investment securities purchased............... 93,617,376
Options written, at value (Premiums received
$8,078,627)............................................ 5,144,725
See accompanying schedule
Payable for fund shares redeemed.......................... 3,376,235
Accrued interest payable.................................. 350,374
Investment advisory fee payable........................... 877,938
Distribution fees payable................................. 189,331
Dividends payable on short positions...................... 409,848
Accrued expenses and other payables....................... 333,767
------------
Total Liabilities................................. 659,871,401
--------------
NET ASSETS.................................................. $1,078,957,547
==============
NET ASSETS Consist Of:
Accumulated undistributed net investment income........... $ 2,327,637
Accumulated undistributed net realized gain on investments
sold, forward currency exchange contracts, securities
sold short, equity swaps, and option contracts expired
or closed.............................................. 64,174,930
Net unrealized appreciation (depreciation) on:
Investments and foreign currency related items......... $(20,881,188)
Short positions........................................ 37,055,379
Written options........................................ 2,933,902
Equity swap contracts.................................. 3,547,609
Forward currency exchange contracts.................... 732,316
------------
Net unrealized appreciation............................ 23,388,018
Paid-in capital........................................... 989,066,962
--------------
Total Net Assets.................................. $1,078,957,547
==============
NET ASSET VALUE, offering price and redemption price per
share ($1,078,957,547/63,835,833 shares of beneficial
interest outstanding)..................................... $16.90
==============
</TABLE>
See notes to financial statements.
13
<PAGE> 14
THE MERGER FUND
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED SEPTEMBER 30, 2000
<TABLE>
<S> <C> <C>
INVESTMENT INCOME:
Interest.................................................. $ 20,236,306
Dividend income on long positions
(net of foreign withholding taxes of $29,392).......... 8,881,476
------------
Total investment income................................ 29,117,782
------------
EXPENSES:
Investment advisory fee................................... $ 7,732,018
Distribution fees......................................... 1,427,450
Transfer agent and shareholder servicing agent fees....... 212,195
Federal and state registration fees....................... 151,955
Professional fees......................................... 143,561
Trustees' fees and expenses............................... 25,463
Custody fees.............................................. 171,160
Administration fee........................................ 353,741
Reports to shareholders................................... 86,300
Other..................................................... 26,532
------------
Total operating expenses before interest expense and
dividends on short positions......................... 10,330,375
Interest expense.......................................... 4,014,885
Dividends on short positions (net of foreign withholding
taxes of $46,668)...................................... 2,655,049
------------
Total expenses......................................... 17,000,309
------------
NET INVESTMENT INCOME....................................... 12,117,473
------------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Realized gain (loss) on:
Long transactions and foreign currency related items... 91,166,309
Short transactions..................................... (14,842,138)
Option contracts expired or closed..................... 6,274,107
Equity swap contracts.................................. 7,057,880
Forward currency exchange contracts.................... 2,248,798
------------
Net realized gain...................................... 91,904,956
Change in unrealized appreciation (depreciation) on:
Investments and foreign currency related items......... (13,818,229)
Short positions........................................ 39,785,046
Written options........................................ 955,907
Equity swap contracts.................................. 3,547,609
Forward currency exchange contracts.................... 922,995
------------
Net unrealized gain.................................... 31,393,328
------------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS............. 123,298,284
------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $135,415,757
============
</TABLE>
See notes to financial statements.
14
<PAGE> 15
THE MERGER FUND
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED SEPTEMBER 30, 2000
<TABLE>
<S> <C> <C>
CASH PROVIDED (USED) BY FINANCING ACTIVITIES:
Sales of Capital Shares..................................... $ 942,097,091
Repurchases of Capital Shares............................... (572,263,075)
Net Change in Receivables/Payables Related to Capital Share
Transactions.............................................. (3,581,716)
---------------
Cash Provided by Capital Share Transactions................. 366,252,300
Cash Used by Borrowings..................................... (94,800,000)
Distributions Paid in Cash*................................. (1,741,613)
---------------
$ 269,710,687
-------------
CASH PROVIDED (USED) BY OPERATIONS:
Purchases of Investments.................................... (5,603,099,079)
Proceeds from Sales of Investments.......................... 5,309,882,151
---------------
(293,216,928)
---------------
Increase in Deposit at Brokers for Short Sales.............. (1,226,751)
Net Investment Income....................................... 12,117,473
Net Change in Receivables/Payables Related to Operations.... (629,510)
---------------
10,261,212
---------------
(282,955,716)
-------------
Net Decrease in Cash........................................ (13,245,029)
Cash, Beginning of Year..................................... 17,820,463
-------------
Cash, End of Year........................................... $ 4,575,434
=============
</TABLE>
------------------------------
*Non-cash financing activities include reinvestment of dividends of $46,260,669.
<TABLE>
<S> <C> <C>
Supplemental Information:
Cash paid for interest.................................... $ 4,473,066
</TABLE>
See notes to financial statements.
15
<PAGE> 16
THE MERGER FUND
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
SEPTEMBER 30, 2000 SEPTEMBER 30, 1999
------------------ ------------------
<S> <C> <C>
Net investment income.................................... $ 12,117,473 $ 2,473,322
Net realized gain on investments sold, forward currency
exchange contracts, securities sold short, equity swap
contracts, and option contracts expired or closed...... 91,904,956 54,231,596
Change in unrealized appreciation (depreciation) on
investments, forward currency exchange contracts, short
positions, equity swap contracts and written options... 31,393,328 24,245,755
-------------- ------------
Net increase in net assets resulting from operations..... 135,415,757 80,950,673
-------------- ------------
Distributions to shareholders from:
Net investment income.................................. (2,863,460) (5,109,498)
Net realized gains..................................... (45,138,822) (25,528,920)
-------------- ------------
Total dividends and distributions...................... (48,002,282) (30,638,418)
-------------- ------------
Net increase in net assets from capital share
transactions (Note 5).................................. 416,094,685 98,744,768
-------------- ------------
Net increase in net assets............................... 503,508,160 149,057,023
NET ASSETS:
Beginning of period...................................... 575,449,387 426,392,364
-------------- ------------
End of period (including accumulated undistributed net
investment income of $2,327,637 and $510,322,
respectively).......................................... $1,078,957,547 $575,449,387
============== ============
</TABLE>
See notes to financial statements.
16
<PAGE> 17
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 YEAR TEN MONTHS YEAR
ENDED ENDED ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, NOVEMBER 30,
2000 1999 1998 1997(7) 1996
------------- ------------- ------------- ------------- ------------
<S> <C> <C> <C> <C> <C>
Net Asset Value, beginning of
period.......................... $15.37 $13.90 $15.35 $15.41 $14.87
Income from investment
operations:
Net investment income........... 0.25(2)(3) 0.08(2)(3) 0.20(2)(3) 0.02(2)(3) 0.20(2)(3)
Net realized and unrealized gain
(loss) on investments......... 2.50 2.71 (0.05) 1.35 1.24
---------- -------- -------- -------- --------
Total from investment
operations.................... 2.75 2.79 0.15 1.37 1.44
Less distributions:
Dividends from net investment
income........................ (0.07) (0.22) (0.03) (0.19) (0.08)
Distributions from net realized
gains......................... (1.15) (1.10) (1.57) (1.24) (0.82)
---------- -------- -------- -------- --------
Total distributions............. (1.22) (1.32) (1.60) (1.43) (0.90)
---------- -------- -------- -------- --------
Net Asset Value, end of period... $16.90 $15.37 $13.90 $15.35 $15.41
========== ======== ======== ======== ========
Total Return..................... 19.08% 21.39% 0.82% 9.68%(5) 10.26%
Supplemental Data and Ratios:
Net assets, end of period
(000's)....................... $1,078,958 $575,449 $426,392 $445,987 $489,084
Ratio of operating expenses to
average net assets............ 1.34%(1) 1.38%(1) 1.33%(1) 1.36%(1)(6) 1.36%(1)
Ratio of interest expense and
dividends on short positions
to average net assets......... 0.86% 1.07% 1.93% 2.93%(6) 0.95%
Ratio of net investment income
to average net assets......... 1.57% 0.54% 1.36% 0.13%(6) 1.36%
Portfolio turnover rate(4)...... 419.24% 386.52% 355.38% 271.24% 276.99%
</TABLE>
------------------------------
(1) For the years ended September 30, 2000, 1999 and 1998, the ten months ended
September 30, 1997, and for the year ended November 30, 1996, 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, 2000, 1999 and 1998, the ten months ended
September 30, 1997, and for the year ended November 30, 1996, were 2.20%,
2.45%, 3.26 %, 4.29%, and 2.31%, respectively.
(2) Net investment income before interest expense and dividends on short
positions for the years ended September 30, 2000, 1999 and 1998, the ten
months ended September 30, 1997, and for the year ended November 30, 1996,
was $0.38, $0.23, $0.49, $0.38, and $0.35, 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 financial statements.
17
<PAGE> 18
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
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, 2000 fair
valued long securities represent 2.4% of investments, 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
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.
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.
18
<PAGE> 19
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
NOTE 2 -- SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
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, adjustments on equity swaps and
unrealized gains or losses on Section 1256 contracts, which are realized, for
tax purposes, at September 30, 2000. The
19
<PAGE> 20
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
NOTE 2 -- SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
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.
20
<PAGE> 21
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
NOTE 2 -- SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 $17,009,423 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. Certain officers of the Fund are also officers of the
Adviser.
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, 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, 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.
21
<PAGE> 22
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
NOTE 5 -- 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, 2000 SEPTEMBER 30, 1999
----------------------------- -----------------------------
SHARES AMOUNT SHARES AMOUNT
------------ -------------- ------------ --------------
<S> <C> <C> <C> <C>
Sold........................ 60,043,484 $ 942,097,091 34,234,589 $ 500,045,668
Issued as reinvestment of
dividends................. 3,145,089 46,260,669 2,104,113 28,405,531
Redeemed.................... (36,804,346) (572,263,075) (29,554,687) (429,706,431)
----------- ------------- ----------- -------------
Net increase................ 26,384,227 $ 416,094,685 6,784,015 $ 98,744,768
=========== ============= =========== =============
</TABLE>
Effective August 9, 1999 through the year ended September 30, 2000, The
Merger Fund was closed to new investors.
NOTE 6 -- INVESTMENT TRANSACTIONS
Purchases and sales of securities for the year ended September 30, 2000
(excluding short-term investments, options and short positions) aggregated
$3,442,212,001 and $2,994,527,287, respectively.
At September 30, 2000, gross unrealized appreciation and depreciation of
investments for federal income tax purposes were:
<TABLE>
<S> <C>
Appreciation................................................ $ 31,464,534
(Depreciation).............................................. (60,933,742)
------------
Net unrealized depreciation on investments.................. $(29,469,208)
============
</TABLE>
At September 30, 2000, the cost of investments for federal income tax
purposes was $1,167,602,054. 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, 2000 of
$2,089,121 which are not recognized for tax purposes until the first day of the
following fiscal year.
22
<PAGE> 23
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
NOTE 7 -- OPTION CONTRACTS WRITTEN
The premium amount and the number of option contracts written during the
year ended September 30, 2000, were as follows:
<TABLE>
<CAPTION>
PREMIUM NUMBER OF
AMOUNT CONTRACTS
------------ ---------
<S> <C> <C>
Options outstanding at September 30, 1999.................. $ 5,717,202 7,063
Options written............................................ 44,325,365 69,122
Options closed............................................. (12,701,423) (15,243)
Options exercised.......................................... (22,643,089) (35,617)
Options expired............................................ (6,619,428) (9,935)
------------ -------
Options outstanding at September 30, 2000.................. $ 8,078,627 15,390
============ =======
</TABLE>
NOTE 8 -- 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, 2000, the Fund incurred
$1,427,450 pursuant to the Plan.
The Plan will remain in effect from year to year provided such continuance
is approved at least annually by a vote either of a majority of the Trustees,
including a majority of the non-interested Trustees, or a majority of the Fund's
outstanding shares.
NOTE 9 -- 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, 1999 to
January 31, 2000, the interest rate on the outstanding principal amount was the
Federal Funds Rate plus 0.875%. The interest rate changed on February 1, 2000 to
the Federal Funds Rate plus 0.75% (weighted average rate of 6.85% during the
year ended September 30, 2000). 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, 2000, the Fund had an outstanding average daily balance of $24,909,258. The
maximum amount outstanding during the year ended September 30, 2000, was
$167,600,000. At September 30, 2000, the Fund had a loan payable balance of
$67,800,000. As collateral for the loan, the Fund is required under the 1940 Act
to maintain assets consisting of cash, cash equivalents or liquid securities.
The assets are required to be adjusted daily to reflect changes in the amount of
the loan outstanding.
23
<PAGE> 24
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
NOTE 10 -- FORWARD CURRENCY EXCHANGE CONTRACTS
At September 30, 2000, the Fund had entered into "position hedge" forward
currency exchange contracts that obligated the Fund to deliver and receive
currencies at a specified future date. The net unrealized appreciation of
$732,316 is included in the net unrealized appreciation (depreciation) section
of the accompanying financial statements. The terms of the open contracts are as
follows:
<TABLE>
<CAPTION>
CURRENCY TO U.S. $ VALUE AT CURRENCY TO U.S. $ VALUE AT
SETTLEMENT DATE BE DELIVERED SEPTEMBER 30, 2000 BE RECEIVED SEPTEMBER 30, 2000
--------------- --------------------------- ------------------ ----------------------- ------------------
<S> <C> <C> <C> <C>
10/27/00 60,133,500 Canadian Dollars $40,005,943 40,433,009 U.S. Dollars $40,433,009
10/30/00 33,810,690 Canadian Dollars $22,496,019 22,801,269 U.S. Dollars $22,801,269
</TABLE>
NOTE 11 -- EQUITY SWAP CONTRACTS
The Fund has entered into both long and short equity swap contracts with
three major broker/dealers: Bear Stearns, & Co., Deutsche Bank and J.P. Morgan
Securities. A long equity swap contract allows the Fund to receive from the
counterparty any appreciation and dividends paid on an individual security and
pay the counterparty LIBOR rate plus between 50 and 100 basis points based on
the notional amount of the contract as well as any depreciation on an individual
security. A short equity swap contract obligates the Fund to pay the
counterparty any appreciation and dividends paid on an individual security and
receive from the counterparty LIBOR rate less between 50 and 100 basis points
based on the notional amount of the contract as well as any depreciation on an
individual security.
Fluctuations in the value of an open contract are recorded daily as a net
unrealized gain or loss. The Fund will realize a gain or loss upon termination
or reset of the contract. Either party, under certain conditions, may terminate
the contract prior to the contract's expiration date.
Credit risk may arise as a result of the failure of the counterparty to
comply with the terms of the contract. The Fund considers the creditworthiness
of each counterparty to a contract in evaluating potential credit risk. The
counterparty risk to the Fund is limited to the net unrealized gain, if any, on
the contract, along with dividends receivable on long equity contracts and
interest receivable on short equity contracts. Additionally, risk may arise from
unanticipated movements in interest rates or in the value of the underlying
securities. At September 30, 2000, the Fund had the following open contracts:
<TABLE>
<CAPTION>
UNREALIZED
TERMINATION DATE SECURITY SHARES APPRECIATION (DEPRECIATION)
---------------- ------------------------ ----------- ---------------------------
<C> <S> <C> <C>
10/19/00 Allied Zurich plc 3,920,896 $1,878,109
12/04/00 Alusuisse Lonza Group AG 11,193 (448,020)
10/05/00 STMicroelectronics N.V. 2,365,800 189,737
11/13/00 WPP Group plc (1,485,783) 1,927,783
----------
$3,547,609
==========
</TABLE>
For the period ended September 30, 2000, the Fund realized gains of
$7,057,880 upon the termination of equity swap contracts.
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 securities sold short and of options
written, and the related statements of operations, of cash flows, 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, 2000, 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 accounting principles generally accepted in the
United States of America. These financial statements and financial highlights
(hereafter referred to as "financial statements") are the responsibility of the
Fund's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
financial statements in accordance with auditing standards generally accepted in
the United States of America, 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, 2000 by
correspondence with the custodian and brokers, provide a reasonable basis for
our opinion.
/s/ PRICEWATERHOUSECOOPERS LLP
Milwaukee, Wisconsin
November 14, 2000
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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, N.A.
P.O. Box 701
Milwaukee, WI 53201-0701
(800) 343-8959
TRUSTEES
Frederick W. Green
Michael J. Downey
James P. Logan III
EXECUTIVE OFFICERS
Frederick W. Green, President
Bonnie L. Smith, Vice President, Treasurer
and Secretary
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(R)]
ANNUAL REPORT
SEPTEMBER 30, 2000
