Merger Arbitrage 101: Investing in Acquisitions with an ETF?

The merger and acquisition market is hot!

Companies flush with cash and short on growth opportunities are looking to mergers and acquisitions to boost their prospects in the near-term. We have seen plenty of deals in this environment, and it looks like this trend might continue for a while longer too.

Obviously, finding potential acquisition targets can lead to big gains, but some investors are looking to the so-called ‘merger arbitrage’ strategy in order to tap into the hot M&A world.  

What is a merger arbitrage strategy? Well, to get some insights on this topic, I spoke with Sal Bruno, CIO at IndexIQ to get his take on this approach for the latest edition of the Dutram Report.

Merger Arbitrage

Generally speaking, when a company announces a takeover, the target firm will see its share price rise, but not up to the full deal value. For example, let’s say a potential target is trading at around $15/share. If a company offers $20/share for the target, the target might see its shares only rise to $19.25/share. This gap between the offer price and the current price is due to the risk of the deal falling through—for any number of reasons—and it is where those employing the merger arbitrage strategy come in to the picture.

Those employing this technique buy up shares of the target company—after the deal has been announced—and look to profit on that gap between the current price and the offer price once the deal closes. It is generally seen as a lower risk and uncorrelated strategy, and Sal Bruno walks us through the mechanics of this approach in the podcast.

Merger Arbitrage ETF?

Additionally, Sal also discusses his company’s fund, the IQ Merger Arbitrage ETF MNA and how this product employs a merger arbitrage strategy in fund form. The technique produces a return that has a surprisingly low volatility level, and has a beta that is extremely low as well (the current beta against the S&P 500 is below 0.3).

Sal also clues us in on the construction of the ETF and how components are decided for the fund, as well as what happens if a deal falls through. We also discuss the fund’s components, and right now this includes Becton Dickinson’s target CR Bard BCR, Time Warner TWX which is being purchased by AT&T, and NXP Semiconductors NXPI which is being acquired by Qualcomm, all of which have more than 7% of the total each. The exposure is pretty diversified all things considered, as five segments each account for at least 10% of the total asset base, and we also touch on the sector biases in this approach as well.

We also discuss some of the mechanics of this technique—such as how companies are removed and why there is a level of short exposure in the ETF—and what the outlook is for mergers and acquisitions under the Trump administration. Make sure to check out the podcast for insights from Sal, and a complete discussion of this strategy!

Bottom Line

But what do you think about the merger arbitrage strategy? Is this something you’ve considered for your portfolio? Make sure to write us in at podcast @ zacks.com or find me on Twitter @EricDutram to give us your thoughts on this, or anything else in the fund market.

But for more news and discussion regarding the world of investing, make sure to be on the lookout for the next edition of the Dutram Report (each and every Thursday!) and check out the many other great Zacks podcasts as well!

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