Merger and acquisition activity is picking up as the world economy gains momentum. Investors can also capitalize on the increased deal making through merger-arbitrage exchange traded fund strategies.
“Merger-arbitrage strategies historically have offered attractive risk-adjusted returns, although there is risk associated with them, as there is no free lunch in the market,” writes Robert Goldsborough, an equity analyst for Morningstar. “M&A-oriented products can offer bondlike returns that are typically uncorrelated with equity or bond market performance. And investors can expect better performance from merger-arbitrage funds in an environment of heightened deal activity because it offers index providers and managers more deals to invest in.”
The increased M&A activity could help boost related ETFs like the Index IQ Merger Arbitrage ETF (NYSEArca: MNA), Credit Suisse X-Links Merger Arbitrage ETN (NYSEArca: CSMA) and ProShares Merger Arbitrage ETF (NYSEArca: MRGR).
The M&A ETFs provide investors with a diversified approach to a group of takeover targets. The ETFs employ a type of alternative, “directional hedge fund strategy” called merger arbitrage. Specifically, the funds capture the spread or difference between a stock’s trading price before a deal is announced and its eventual takeover price. [ETFs to Capture the Rise in M&A Activity]
“The spread between these two prices typically exists due to the uncertainty that the announced merger or acquisition will close and, if it closes, that such merger or acquisition will be at the initially proposed economic terms,” according to Credit Suisse.
However, the strategy exposes investors to deal risk, or the risk that an announced deal could fall through. Deal risk, though, diminishes in an improving economic environment since there is less uncertainty.
Additionally, the M&A ETFs may take a short position in the acquiring company or broadly short the global equity markets as a partial hedge.
For instance, MNA tracks a benchmark of announced takeover targets but also shorts the global market. Additionally, unlike the other M&A exchange traded products, MNA includes global deals, such as British soda maker Rexam PLC, which has been targeted by Ball Corp (NYSE: BLL).
CSMA, an exchange traded note, takes long positions in deal targets and also shorts positions in the acquiring firms. The ETN also takes some international exposure, covering deals in the U.S., Canada and Western Europe.
MRGR includes a group of deal targets and their acquisitiors. The ProShares option also takes long positions in acquisition target stocks and short positions in acquiring companies in stock-for-stock deals. Each short position can range between 0% to 3%, depending on the terms of the deal.
For more information on M&A funds, visit our mergers and acquisitions category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.