Merger Arbitrage Will Increase in 2010: Here's an ETF to Play the Trend

Jan. 4.10 | About: IQ ARB (MNA)

The ETF industry continues to innovate as IndexIQ, a leading developer of index-based alternative investment solutions, has introduced the first merger arbitrage Exchange-Traded Fund designed to give investors exposure to global corporate merger & acquisition activity which is rapidly increasing. This is good timing for an M&A Fund because global mergers and acquisitions are expected to pick up after the global financial meltdown and while companies have a significant amount of cash that can't make much money from low interest rates.

The IQ ARB Merger Arbitrage ETF (NYSEARCA:MNA) seeks to provide capital appreciation by investing in global companies for which there has been a public announcement of a takeover by an acquirer, a strategy generally known as “merger arbitrage.” This strategy generally seeks to take advantage of the price differential, where it exists, between the current trading price of a stock and the price of that stock at the time the deal is completed.
“To date, investors have not had broad access to capitalize on mergers and acquisitions activity in an ETF,” said Adam Patti, chief executive officer at IndexIQ. “The Merger Arbitrage ETF is a hedged strategy designed to take advantage of price disparities that exist in merger activity and strengthen investor portfolios by buying below the target price and realizing the capital appreciation if the deal closes at or above the target price. As such a strategy has not previously been accessible in an ETF offering investors a highly liquid, transparent, low cost, and easily tradable product, we are very excited about providing this ETF solution to investors.”
Merger Arbitrage funds typically have the potential to benefit from buying target companies below the target price. The “spread” in price, the difference between the target price and market price, can be quite lucrative for investors, especially if there are competitive bids for a company.

Given today’s relatively low corporate valuations and the significant amount of cash on corporate balance sheets, industry experts forecast a rapid increase in M&A activity. Cash on the books of non-financial companies in the S&P 500 Index hit a record of more than $700 billion as of June 2009, up more than 8% in the past year and 16% above the level of two years ago, according to S&P. The IQ ARB Merger Arbitrage ETF, the first of its kind, provides investors unique access to this trend.

As an indication of the improving outlook, nine deals with a total value of $19.9 billion were announced from the start of December through Christmas Eve. That came on top of November's 14 M&A announcements, which were valued at $63.175 billion - although that number was distorted somewhat by Warren Buffett's $26.52 billion bid for the 78% of Burlington Northern Santa Fe Corp. (BNI) he didn't already own.

Despite the notion that the ETF will invest in equities, this index does not really give equity returns. Seeing as that the majority of announced public mergers do close, this generally tends to offer enhanced returns compared to bonds. Here is the performance data (in percentages) from IndexIQ:

Again, this is not just US mergers as it can invest in major developing countries. It also has guidelines over the certainty of a merger’s chances of closing and is reconstituted and rebalanced monthly. No single common stock index component may have a weighting greater than 15% at each rebalance and reconstitution date.

The Fund carries an expense ratio of 0.75%. Being new to the market in December, place this ETF on your watch list to see what type of returns can be generated. If it can effectively match the ARB Merger Arbitrage Index, then the returns will be promising.

Disclosure: No positions