While the U.S. bull market rally extends, there is a growing risk of a short-term correction, especially given the lofty valuations in domestic equities. Consequently, investors have turned to various assets like liquid alternatives and related exchange traded funds to isolate returns from broad market influences.
For instance, the Index IQ Merger Arbitrage ETF (NYSEArca: MNA) provides investors with a diversified approach to a group of takeover targets. The ETF employ a type of alternative, “directional hedge fund strategy” called merger arbitrage. The fund would capture the spread or difference between a stock’s trading price before a deal is announced and its eventual takeover price.
Merger arbitrage is a hedged, alternative investment strategy designed to take advantage of price discrepancies that exit for companies involved in a merger. The strategy would purchase companies at prices below the target price and lock in the difference, or spread. By targeting this spread, the generated returns are generally outside of normal fluctuations of the broader market.
“Historically, merger arbitrage strategies have provided diversification and stable returns across various market environments,” according to an IndexIQ note.
A merger arbitrage investment strategy may help investors garner more consistent returns and possibly deliver a smoother ride, serving as an important capital preservation tool and providing drawdown protection in times of volatile market conditions.
Along with its drawdown protection potential, a merger arbitrage strategy can also improve the risk-to-return profile of a traditional investment portfolio since the drivers of return for this type of strategy are isolated from broad market moves.
Consequently, since the strategy is not expected to be highly correlated to other asset classes over time, investors may find a stable platform in stormy weathers if U.S. markets suddenly correct, which is more likely to happen in an extended bull market condition.
For more information on alternative strategies, visit our alternatives category.