An Obscure, Intriguing Fund Worth Discovering

The Pennsylvania Avenue Event-Driven fund comes out of a classic mom-and-pop shop. Only the mom is absent. Pop in this case is Thomas Kirchner, a 39-year old native of Germany. Working out of his apartment in the upper Northwest section of Washington, D.C., he not only picks the fund's stocks and bonds, but also answers the phone and stuffs envelopes with prospectuses and shareholder reports.

Truth be told, the work is not as onerous as it seems. The fund (symbol PAEDX), which was launched in November 2003, is small, really small. Assets total just $2.5 million, and there are only 200 shareholders. The occasional dollop of publicity the fund has received has not led to a stampede of would-be investors.

Yet this is an intriguing fund. Let's start by parsing the name. Pennsylvania Avenue is, of course, the most famous street in the nation's capital (but not the one on which Kirchner's office is located). Event-driven means that the fund invests in securities affected by corporate events, such as mergers or bankruptcies. Specifically, the fund focuses on four strategies:

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• Merger arbitrage. This means buying the shares of a takeover target after a deal is announced in the hope of capturing the final few pennies or dollars of appreciation between the post-announcement price and the price at which the deal is consummated.
• Capital structure arbitrage. This involves investing in different types of securities from the same company to take advantage of pricing inefficiencies.
• Distressed securities. Usually, this refers to investing in bonds of companies in bankruptcy reorganization.
• Proxy fight investments. Kirchner invests in companies that outsiders seek to gain control of, typically because they think the stock is undervalued.

At present, says the German-accented Kirchner, between two-thirds and three-fourths of the fund's assets are in merger stocks. Most of the rest is in the shares of companies involved in proxy fights. Deal stocks are especially attractive, Kirchner says, because private-equity firms have a lot of incentive to consummate deals because they have so much money to spend. "I don't see any opportunities in distressed securities right now," he says. The fund's biggest holdings at last report were high-yielding Winn Dixie bonds and shares of Northwestern Corp., Central Freight Lines, Capital Title Group and Titan International.

So far, Kirchner has put up good numbers. In 2004, the fund's first full year, it gained 27%, beating Standard & Poor's 500-stock index by 16 percentage points. It returned 12% in 2005, seven percentage points ahead of the index; and it climbed 11% last year, five points behind the index. Over the past three years through February 22, the fund returned 15% annualized, beating the SP by an average of four percentage points per year, according to Morningstar.

The fund's volatility over the past three years has been about the same as the SP 500's. But Kirchner is candid in acknowledging that his product hasn't yet been put through the wringer. Says he: "The fund is potentially risky. We've not had a major financial problem since I started it. If we had a serious problem with the high-yield bond market and many mergers suddenly started to fall though, this fund would be riskier than the numbers indicate."

Both Standard & Poor's and Morningstar categorize Pennsylvania Event-Driven as a small-company value fund. That may reflect the fund's current holdings, but the categorization doesn't really do justice to the fund's unusual investment style. You could lump it together with the Merger and Arbitrage funds, which Morningstar calls long-short funds, but at present Kirchner isn't shorting any stocks (deal investors will typically short shares of the acquiring company when it plans to pay for all or part of the purchase with its own shares).

This fund has a lot of fine attributes. The strategy is appealing, and the tiny asset base gives Kirchner a lot of flexibility. The fund doesn't levy sales charges and, despite its smallness, annual expenses are a reasonable 1.5% (Kirchner says the fund is breaking even and that he's living off savings as he waits for assets to grow). The fund's record, albeit brief, is good.

But this is Kirchner's first endeavor at professional money management. According to the fund's prospectus (call 888-642-6393 for a copy or visit www.pafunds.com), Kirchner spent 1996 to 1999 as a bond trader and "financial engineer" at Banque Nationale de Paris and 1999 to 2004 as a "financial engineer" for Fannie Mae. As a result of Kirchner's limited experience and the absence of a long-term track record, it's hard to give the fund a ringing endorsement, although it is clearly a fund that's worth watching.

Fortunately, you can get some sense of Kirchner's thinking by visiting his blog, The Deal Sleuth (http://thedealsleuth.wordpress.com). Or just call the toll-free number above. Unless this article results in a flood of calls, you'll probably be able to speak directly with the manager himself.