While I love to discuss trade ideas and trends from the world of ETFs, I also think it's useful to take an educational look at the ETF world every now and then. ETFs are a dynamic asset class and with so many different investment ideas and genres available, it pays to take a look at exactly what you're getting before you commit your hard-earned money to any ETF.
Last month, I addressed some ETFs that simply aren't worth your trouble, regardless of circumstances, and I followed that up with a piece on the value of knowing exactly what your ETF's objectives are. In this piece, I want to tie those themes together because I've noticed that there are a few ETFs in the marketplace that by any definition are obscure, but they have alluring names that may trick unknowing investors into a trade they don't fully understand.
Storied value investor Peter Lynch used to say "Know what you own." Of course he was talking about stocks, but that phrase is definitely applicable to ETFs as well. Knowing what you own with ETFs is really easy and part of that is not being tricked by an ETF's name. Let me give you one example that is quite relevant to what's going on in today's market environment: The IQ Merger Arbitrage ETF (NYSE: MNA).
MNA made its debut in mid-November and is up just over 4% in that time. The ETF has flown under the radar, probably due to low trading volume, until recently when investors were hit with a flurry of mergers & acquisitions news. In the past week alone, First Niagara (Nasdaq: FNFG) said it would acquire NewAlliance (NYSE: NAL), Intel (Nasdaq: INTC) announced its purchase of McAffee and Dell (Nasdaq: DELL) and Hewlett-Packard (NYSE: HPQ) are going to duke it out for 3Par (NYSE: PAR).
There was also a rumor that Arcelor Mittal (NYSE: MT) may be interested in U.S. Steel (NYSE: X), but all of these deals pale in comparison to the drama and size of the BHP Billiton (NYSE: BHP)/Potash (NYSE: POT) news. By looking at MNA's name and ticker, one might think the ETF is on fire lately. Wrong. In the past six days, the ETF is down, albeit slightly, and there has been no noticeable uptick in volume despite a robust flow of M&A news.
That's a pretty disappointing run for an ETF believed to be a way to play M&A activity, but it's also easy to explain. Just take a look at the chart below, which highlights MNA's top-10 holdings. You won't see any of the companies mentioned above among MNA's biggest positions.
To be clear, I'm not knocking MNA, nor do I think it's a bad ETF. What is undeniable is that this ETF has a name that's easy to misunderstand. MNA would make for a great play on M&A activity if it built a portfolio of stocks that were viewed as takeover candidates, thereby harnessing the best move in those stocks because the ETF would own them BEFORE takeover news hits the wires. That's actually not a bad idea for an ETF, but MNA doesn't do that.
Actually, MNA's title is quite clear about what it does for one key reason: The word arbitrage. In merger speak, arbitrage is used by professional traders to exploit the risk that a deal won't close on time or at all. If the market believes the risk is high, then the stock of the target firm will trade at a discount to the deal's value.
Complex stuff, but perhaps this explains why MNA isn't the way to play recently announced or anticipated M&A news. The ETF likely won't have the affected stocks in its portfolio until after the deal is announced.
MNA is just one example of how an ETF's title can be a tad confusing. There are scores of others across every corner of the ETF universe, but you can avoid the confusion simply by going straight the to issuer's Web site and seeing for yourself exactly what any ETF is supposed to do and what its holdings are.
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Disclosure: No positions