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An Alternative ETF Strategy to Diversify Against Risks Ahead

This article was originally published on ETFTrends.com.

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.

Kelly Ye, Director of Research at IndexIQ, argued that investors can isolate equity returns from broad market influences through something like the Index IQ Merger Arbitrage ETF (MNA) . The underlying IQ Hedge Merger Arbitrage Index has exhibited a correlation of 0.35 to the S&P 500 and a 0.05 to the Bloomberg Barclays U.S. Aggregate Bond Index.

"IndexIQ’s MNA is a liquid solution, designed to diversify your portfolio by seeking to provide downside mitigation in volatile markets and upside potential when markets recover," Petersen added.

Furthermore, through the ETF wrapper, investors can gain exposure to the even-driven, merger arbitrage strategy that has traditionally been associated with mutual funds or hedge funds. Something like MNA would provide the tax efficiency and low probability of capital gain distribution that many have enjoyed in an ETF.

Financial advisors who are interested in learning more about the merger and acquisition arbitrage strategy can watch the webcast here on demand.