It is no secret that generating steady returns in equity markets has been a daunting task. The market has been extremely rocky in 2010 as a stellar July was washed away by extreme levels of weakness in the early part of August. These moves have leveled out equities to produce a sideways trend, leaving many investors baffled on how to make a play going forward. Some have abandoned their equity posts altogether, taking shelter in fixed income while they wait out the storm. However, others have taken a more novel approach, utilizing innovative Hedge Fund and Quantitative Methodology ETFs in order to profit from an unpredictable financial environment [see ETF Ideas For A Flat Market].
In turbulent economic times, it is not uncommon for struggling companies to be bought out by larger, more stable firms. Likewise, some companies merge to boost profits and create synergies in order to form some of the world’s largest business juggernauts. Some of these larges mergers have had mixed results, including the disastrous union between AOL and Time Warner, as well as the more famous and successful partnership between Exxon and Mobil, which has created one of the largest publicly traded companies on the globe.
In a typical merger or acquisition, barring some of the extreme circumstances we have seen with the financial crisis in which companies were purchased at hefty discounts, one company generally purchases the other at a large premium of the acquisition’s current share price. The respective companies’ share prices will then skyrocket to a level just below what the deal went through for, allowing investors to buy in at a slight discount. The discount results from the small risk that the deal will not go through and the prices will tumble. However, if the deal goes off without a hitch, as many do, the share price will rise slightly up to the purchase price allowing investors to profit off of this ‘merger arbitrage’ strategy [see Will Cash-Rich Companies Boost MNA and PKW?].
Though the best way to profit from these moves is by owning the stock before the announcement, or by owning hedge funds that utilize this strategy, investors can still make considerable gains by using ETFs. The IQ ARB Merger Arbitrage ETF (MNA) aims to take advantage of this process giving its investors opportunity to profit even in the weakest of markets; the fund has a beta of just .03 suggesting that it tends to move relatively independent of the overall ups and downs of broad U.S. equities [also read Closer Look At Hedge Fund ETFs].
Behind The Scenes
IndexIQ‘s MNA tracks the performance of the IQ ARB Merger Arbitrage Index, which seeks to achieve capital appreciation by investing in global companies for which there has been a public announcement of a takeover by an acquirer. The Index also includes short exposure to global equities as a partial equity market hedge. The fund focuses on the energy and communications sectors while keeping the vast majority of its assets in the U.S. Though MNA has not posted massive gains since its inception in late 2007, it has outperformed global equities as a whole, entering the market just before the worst recession in nearly 70 years. A $10,000 investment in MNA at its inception would have yielded $10,511 at the end of the second quarter this year while the same investment in a fund tracking the MSCI All Country World Index such as the MSCI All Country World Index Fund (ACWI) would have yielded just $8,731 at the end of last quarter, showing that this ETF’s methodology is able to outperform in both good times and bad. [see MNA's fact sheet here].
The fund’s top holdings include some of the biggest acquisitions from the recent past across a wide range of industries. Coming in as the top holding, with over 11% of the entire fund is Smith International, which was bought out by Schlumberger in February of this year. The sale price was for $45.84 per share, and Smith International topped that number in late April trading at nearly $49 per share. MNA’s second highest holding comes from Qwest International, of which a takeover was announced earlier this year, but not expected to push through until early to mid 2011 allowing MNA to execute its merger arbitrage strategy. MNA has been able to stay afloat in rough times with its one of a kind strategy that is offered nowhere else in the ETF space. With publicly announced mergers and acquisitions usually being stable deals, this ETF presents itself as an interesting play no how the markets are behaving [see more charts of MNA here].
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Disclosure: Photo courtesy of Patrick Theiner. No positions at time of writing.