Now Is The Season To: May 2011

Published on by on May 2, 2011

Consider Merger Arbitrage ETPs

Investors have been cautiously adjusting their portfolio positions and seeking out alternative investment strategies as global economic uncertainties continue to put pressure on equity markets. Luckily the exchange-traded product structure has evolved tremendously in bringing forth an extensive amount of investing and trading strategies and bundling them into liquid securities available to investors of all walks. Merger arbitrages strategies aren’t anything new as they have been quite popular amongst sophisticated investors and hedge funds, but the strategy has only recently become available to the average investors.

The merger arbitrage strategy involves purchasing shares of companies after a proposed acquisition has been announced. Once a transaction is announced however, there are still certain obstacles before the deal is complete including possible regulatory obstacles and even shareholder objections. By investing in a basket of takeover targets investors can profit if the deal is ultimately completed by collecting the spread between the purchase price and the deal price. The merger arbitrage strategy will often appeal to longer term buy-and-holders as it is know to exhibit a relatively low correlation to the broader equity markets and deliver consistent returns.

  • IndexIQ Merger Arbitrage ETF (MNA)- This is the first fund to launch implementing the merger arbitrage strategy and it is linked to the IQ ARB Merger Arbitrage Index, a benchmark that includes 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.As of 12/31/2010 the IQ ARB Index included significant allocations to:-Del Monte Foods: Consumer Staple (9.21%)
    -Commscope Inc: Information Technology (9.15%)
    -Genzyme Corp: Health Care (7.42%)
    -Bucyrus International: Industrials (6.08%)
    -McAfee: Information Technology (5.79)
  • Credit Suisse Merger Arbitrage Liquid Index (CSMA)- This ETN is linked to an index designed to employ a merger arbitrage strategy by using a quantitative methodology to track a dynamic basket of securities held as long or short positions to reflect publicly announced merger transactions. The fund seeks out to buy stocks that have been announced as takeover targets but for which the transaction has not yet closed. Because there is usually some degree of uncertainty as to whether an announced transaction will ultimately be consummated, takeover targets will often trade at a discount to the announced target price. Credit Suisse also offers the 2x Monthly Leveraged Credit Suisse Merger Arbitrage Liquid Index ETN (CSMB), which is the same as CSMA except it delivers 200%  leveraged exposure on a monthly basis.As of 04/20/2011 the CS Merger Arbitrage Liquid Index included significant allocations to:-Progress Energy: Energy (4.40%)
    -Bucyrus International: Industrials (4.20%)
    -Dollar Thrifty Automotive: Consumer Services (3.80%)
    -Nstar: Utilities (3.80%)
    -Danisco: Biotechnology (3.60%)

It’s important to consider the differences between an ETF versus and ETN product structure relative to the unique risks and rewards of the merger arbitrage strategy. Since the strategy can be quite risky to implement if you’re betting on a few takeover targets, it’s  ideal for the ETF wrapper, as the structure allows investors to spread out risk across multiple target companies. But because this strategy requires securities to be held for only a limited period of time–when the transaction is completed, the fund often receives cash for the acquired company which can dull the traditional tax efficiencies  of ETFs. Likewise, the ETN product is an unsecured debt instrument that doesn’t actually hold the target stocks, which can allow for investors to avoid incurring short-term capital gains.

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