ETF Trends
ETF Trends

By Yazann Romahi via Iris.xyz

The hedge fund landscape is changing. Recent research has made it clear that a significant component of the returns from the main hedge fund styles are generated not only by fund managers’ skill, but as compensation for taking on some form of risks itself, or “beta.” The process is analogous to that of equity index fund investing, but instead of a large universe of stocks, investors hold a large universe of merger deals. The discovery is increasingly making it possible to attain hedge-fund-like returns, and diversification, through liquid, low-cost funds.

Merger arbitrage, a well-established hedge fund style, illustrates this possibility.

Traditionally, an active merger arbitrage manager will invest in a company being acquired, post the announcement of the merger but before the merger actually takes place while shorting the offering company. The premise is to capture the premium between the offer price and the prevailing price of the target stock. If the deal completes, the investor realizes a small return; if it fails, the investor faces potentially a large loss as the target stock drops back to the pre-offer price. The active manager would argue that skill is the key in determining the subset of deals to buy that are likeliest to complete.

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