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How To Access M&A Deals In ETFs

Cinthia Murphy

Merger and acquisition deals are at fever pitch this year. This week alone, we saw three big deals announced: Raytheon (RTN) to merge with United Technologies (UTX); Salesforce (CRM) to buy Tableau Software (DATA); and Merck (MRK) to buy Tilos Therapeutics.

An ETF investor or trader can access these deals—playing them somehow—in two easy ways. The first is by looking into merger arbitrage ETFs such as the IQ Merger Arbitrage ETF (MNA).

MNA is a portfolio that owns the targets of acquisitions. The idea behind this strategy is to capitalize on stock price gains of acquired firms.

Premium Play

Typically, acquirers offer a premium for companies to get shareholders on board with the deal. Assuming the deal goes through, the stock price of those companies should rise over time to match or exceed that premium being offered. MNA sets out to capture that ride.

New acquisition targets are added at the fund’s monthly rebalance (the beginning of every month), so in this week’s case, the deals announced would show up in MNA at its upcoming July rebalance. Shares of United Technology and Tableau Software would be included in the portfolio.

 

(Use our stock finder tool to find an ETF’s allocation to a certain stock)

 

As a merger arbitrage strategy, MNA also seeks to hedge that long bet. One way to hedge that type of deal is by shorting the stock you expect to receive in payment. MNA, however, shorts the entire sector rather than the single stock in deals where payment is being done through company stocks rather than cash.

Why? Because, historically, sectors where there's M&A activity can get inflated, and eventually correct, while stock prices of acquirers tend to outperform their broader sector once the market realizes the long-term benefits of the planned acquisition, according to IndexIQ.

In the Raytheon deal, MNA would go long United Tech stocks and short the industrials sector. In the Salesforce deal, it would short technology.

By shorting the sector and going long the target, MNA protects returns in the event stock prices of the buyer or the entire sector go down, but it also allows itself to capture any upside in the buyer stock through gains it sees in the acquired stock as part of the deal, and by the eventual completion of the deal.

Resulting Low Volatility

It’s a hedging mechanism that allows the portfolio to have a low volatility profile, as well as low beta to global equities, currently at 0.28; and little to no correlation to fixed income, currently pegged at 0.10. MNA is a strategy that’s a true portfolio diversifier due to its low and uncorrelated returns. 

MNA has a 0.78% expense ratio, an attractive price tag for this type of strategy, and one that, thus far, has done well attracting assets. MNA has nearly $1 billion in assets under management, and average daily volume of $5.5 million.

 

Chart courtesy of StockCharts.com

 

Most deals stay in the MNA portfolio for up to 360 days, or until they are completed or canceled before that. Deal cancellation rate is pretty low, at 3%, but this year, it has certainly impacted MNA’s performance. Remember that by owning MNA, you are exposing yourself to deal risk. 

In the past year or so, some big deals fell through, according to IndexIQ, such as when Husky Energy dropped its takeover bid for MEG Energy earlier this year. That impacts returns, and year to date, MNA hasn’t really delivered much to investors in total returns.

Another Way To Access M&A Deals

Now, say, that you want to access the Merck acquisition of Tilos Therapeutics. Tilos is a private company—there are no stocks of Tilos Therapeutics sitting in ETF portfolios. Because it’s a deal involving a private name, it will not land in the MNA portfolio.

The only way to play this deal would be through allocations to Merck stock. At ETF.com, we have a stock finder tool that allows you to find what ETFs hold any specific company you are looking for. Go to www.etf.com/etfanalytics/etf-stock-finder and type the ticker—in this case, MRK—into the search box.

 

 

You will find that Merck is in 243 different ETFs today. From a sector perspective, Merck is a health care company, so it’s unsurprising to see Merck stock in the Health Care Select Sector SPDR Fund (XLV). Merck represents about 6.5% of XLV’s portfolio weighting, which amounts to $1.1 billion worth of Merck stock at current prices.

 

 

On average, U.S. ETFs allocate only 1.39% to Merck in their portfolios, but you can also—in our tool—find that the First Trust Nasdaq Pharmaceuticals ETF (FTXH) has an 8.5% allocation to the company, the biggest portfolio weighting to this company in any ETF wrapper.

That allocation equates to slightly more than $500,000 worth of Merck stock—a fraction of the market value found in XLV—but the weighting is FTXH’s second largest single-stock allocation. That means movements in Merck stock prices would have a much bigger impact on the overall performance of FTXH than they would in XLV.

Merck stock may be included in portfolios you might not necessarily think of when you think of a pharmaceutical giant. For example, you will find Merck at above average levels in the iShares Edge MSCI U.S.A. Momentum Factor ETF (MTUM), where a 5% allocation has a market value of about $410 million.

Also In Quality & Dividend ETFs

If you are a quality-factor ETF investor, you will also find Merck in the Invesco S&P 500 Quality ETF (SPHQ), where the stock represents about 3.8% of the portfolio. And you can run into Merck if you are looking for dividend payers, too, in the Amplify CWP Enhanced Dividend Income ETF (DIVO), where Merck is a 5% allocation.

You can also easily find that, out of 243 ETFs investing in Merck today, 28 of them are actively managed, so you can also choose between passive and active bets on this stock through ETFs. Depending on how you feel about the announced M&A deal involving Merck, and whether you want to own more or trim exposure to that stock, it helps to know all of the ETFs where you might be allocated to this pharma name.

Contact Cinthia Murphy at cmurphy@etf.com

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