An Alternative ETF Strategy to Diversify Against Risks Ahead

ETF investors can potentially reduce portfolio risk while taking advantage of the transformative merger and acquisition market.

On the recent webcast (available On Demand for CE Credit), Capitalizing on the Transformative M&A Market, Dan Petersen, Director of Product Management at IndexIQ, explained that the merger arbitrage strategy that takes advantage of the merger and acquisition process is seen as an alternative, event-driven hedge-fund replication investment methodology that investors can take advantage of to diversify and enhance their portfolios.

“We see opportunity in M&A as new tax reform, deregulation across select industries, and continued economic expansion provide a high likelihood that record M&A activity continues,” Petersen said.

Specifically, Petersen highlighted the fact that there were $5.4 trillion in merger and acquisition activity in 2017 and another $1.6 trillion year-to-date, setting the pace fo record deals. Tax reforms have cut the corporate tax rates to 21% from 35% and the cash repatriation holiday allowed large multi-national companies to bring cash back at a 15.5% rate instead of the 35%, which leaves many companies with more money to acquire smaller businesses. Additionally, the synchronized global growth and deregulation may serve as a catalyst for deal opportunities.

Deal Premiums in North America

All of this means that despite high equity market valuations, deal premiums in North America are spiking to levels last seen in 2015 and 2009, when the market was much lower and companies were willing to pay a premium.

To take advantage of this heightened M&A activity, Mark Lacuesta, Director of Index Strategies at IndexIQ, argued that investors could look to a merger arbitrage strategy. The strategy is designed to take advantage of price discrepancies that exist for companies involved in a merger; can be used as a hedged or alternative investment strategy that benefits by purchasing companies at prices below the target price and capturing the remaining premium; and targeting this spread seeks to deliver returns that are generally immune from fluctuations of the broader market. Additionally, merger arbitrage strategies have historically generated relatively stable returns across various market environments.