Merger Arbitrage ETF Debuts

by on November 17, 2009 | ETFs Mentioned:

IndexIQ, the ETF issuer behind the first hedge fund ETFs, has brought its fifth exchange-traded product to market, the IQ ARB Merger Arbitrage ETF. The fund began trading Tuesday on the NYSE Arca Exchange under the clever ticker MNA. The new ETF will track 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.

New York Stock ExchangeEven after a deal is announced, most publicly-traded target companies generally trade at a discount to the stated offer price, reflecting some degree of uncertainty that the deal will ultimately close. While the vast majority of announced transactions are ultimately consummated, it is not unheard of for regulatory hurdles, lawsuits, and financing issues to derail deals.

Merger arbitrage strategies are nothing new, but MNA represents the first time such tactics are being made widely available through the ETF structure. Merger arbitrage seeks to generate gains by purchasing stocks of takeover targets for less than the announced transaction price. By holding these investments until the transaction closes, investors can pocket the difference (see a good list of current merger arbitrage opportunities here). It sounds like a sound investment play and has the potential to deliver solid returns. But the merger arbitrage strategy comes with commensurate risk. If the deal closes, a profit can be made. But if the deal falls through, investors can be left holding the bag.

As of November 16, the IQ ARB Index included significant allocations to:

  • Starent Networks (8.7%): Provider of core technology that enables mobile operators to deliver mobile broadband services. In October, Starent agreed to be acquired by Cisco Systems for $35 per share.
  • Target Acquiror Offer Price Target Price* Discount
    Starent Cisco $35.00 $34.08 2.6%
    BJ Services Baker Hughes $20.04 $19.79 1.2%
    Sun Oracle $9.50 $8.65 8.9%
    * As of November 16, 2009
  • BJ Services (8.3%): Provides fracturing services for for major shale oil and gas operators. In August, Baker Hughes announced it would acquire BJ Services for $5.5 billion.
  • Sun Microsystems (7.9%): Vendor of computers, components, and IT services. In April, Sun agreed to be acquired by Oracle.

MNA is the third ETF launched by IndexIQ in the last month, joining two funds aimed at combating inflation, the IQ ARB Global Resources ETF (GRES) and CPI Inflation Hedged ETF (CPI). Future fund launches could include a 130/30 ETF, as the issuer recently took the first step towards bringing a long/short product to markets.

Disclosure: No positions at time of writing.