At Apollo our investment strategies have always included a focus on minimizing risk. There are many tricks to the trade. One we’ve used consistently throughout our 20+ years of advising clients is the inclusion of Merger & Acquisition Arbitrage (“M&A Arb”) in the construction of asset allocations.

In its simplest form M&A Arb strategies are implemented by purchasing the stock of an acquisition target (e.g. Time Warner Cable) and, simultaneously, shorting the stock of the acquiring company (e.g. Comcast). Profits are earned on the spread between the target’s current price and the buyout price. Losses are possible if the deal doesn’t go through.

M&A Arb is appealing as a diversifier because it’s market-neutral. Risks are limited to deals being canceled – a very different type of risk than traditional stock market risk – so beta is nearly zero.

The strategy’s relatively recent popularity, however, has nothing to do with the wonderful diversification benefits.

1) M&A Arb strategies benefit from rising interest rates. Investors have used it as an alternative to fixed-income at a time when the 10-year Treasury is barely north of 2%.

2) Market-neutral funds by definition have returns that can and will deviate from the overall stock market. Consider that in the second half of 2008 when the S&P 500 lost 29.7% the two largest retail M&A Arb funds (Merger Fund “MERFX” and Arbitrage Fund “ARBFX”) delivered positive returns of 0.98% and 2.1% respectively. The result? The combined assets of the two funds jumped from $1.5 billion in 2008 to $2.9 billion by 2009 and today has reached almost $8 billion.

This second point is an important one. This kind of asset growth suggests investors are flocking to M&A Arb because of historical returns…or maybe it’s a way to feel protected in the wake of the sizable losses of 2008 that cause worry and fear in today’s investors.

So here’s the rub. While the 2008 second half returns of MERFX and ARBFX weren’t eye-popping on an absolute basis they were incredible on a relative basis. That’s a problem.

Why? We’ve reached the time of year when, traditionally, many investors sit down and spend five minutes on their portfolios. Sure they spent hours researching “important” things such as where to go on vacation or which iPhone to buy but now it’s time for some “real” financial analysis. And how is this accomplished? Pull out the returns for the S&P 500 and compare. If there’s under-performance then something’s wrong. This is the “proper” way to evaluate things, isn’t it? After all how can years of having this drilled into our heads be wrong?

The lesson is as always. Ignore returns. Ignore blind comparisons. In fact, ignore comparisons altogether. Instead focus on what you own and why. Only then can an intelligent decision be made about whether an investment fits with the theme of a portfolio.

Sadly most investors will ignore this advice. Human nature being what it is they’ll look for information that confirms their beliefs while ignoring information that contradicts them. They’ll look at “last year’s winners.” They’ll “buy high and sell low.” They’ll suffer the consequences. They’ll rationalize the negative outcomes by claiming markets are rigged.

Haven’t we seen this movie before?