Merger and acquisition deals are at fever pitch this year. This week alone, we saw three big deals announced: Raytheon (RTN) to merge with United Technologies (UTX); Salesforce (CRM) to buy Tableau Software (DATA); and Merck (MRK) to buy Tilos Therapeutics.
An ETF investor or trader can access these deals—playing them somehow—in two easy ways. The first is by looking into merger arbitrage ETFs such as the IQ Merger Arbitrage ETF (MNA).
MNA is a portfolio that owns the targets of acquisitions. The idea behind this strategy is to capitalize on stock price gains of acquired firms.
Premium Play
Typically, acquirers offer a premium for companies to get shareholders on board with the deal. Assuming the deal goes through, the stock price of those companies should rise over time to match or exceed that premium being offered. MNA sets out to capture that ride.
New acquisition targets are added at the fund’s monthly rebalance (the beginning of every month), so in this week’s case, the deals announced would show up in MNA at its upcoming July rebalance. Shares of United Technology and Tableau Software would be included in the portfolio.
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As a merger arbitrage strategy, MNA also seeks to hedge that long bet. One way to hedge that type of deal is by shorting the stock you expect to receive in payment. MNA, however, shorts the entire sector rather than the single stock in deals where payment is being done through company stocks rather than cash.
Why? Because, historically, sectors where there’s M&A activity can get inflated, and eventually correct, while stock prices of acquirers tend to outperform their broader sector once the market realizes the long-term benefits of the planned acquisition, according to IndexIQ.
In the Raytheon deal, MNA would go long United Tech stocks and short the industrials sector. In the Salesforce deal, it would short technology.
By shorting the sector and going long the target, MNA protects returns in the event stock prices of the buyer or the entire sector go down, but it also allows itself to capture any upside in the buyer stock through gains it sees in the acquired stock as part of the deal, and by the eventual completion of the deal.
Resulting Low Volatility
It’s a hedging mechanism that allows the portfolio to have a low volatility profile, as well as low beta to global equities, currently at 0.28; and little to no correlation to fixed income, currently pegged at 0.10. MNA is a strategy that’s a true portfolio diversifier due to its low and uncorrelated returns.
MNA has a 0.78% expense ratio, an attractive price tag for this type of strategy, and one that, thus far, has done well attracting assets. MNA has nearly $1 billion in assets under management, and average daily volume of $5.5 million.
Chart courtesy of StockCharts.com
Most deals stay in the MNA portfolio for up to 360 days, or until they are completed or canceled before that. Deal cancellation rate is pretty low, at 3%, but this year, it has certainly impacted MNA’s performance. Remember that by owning MNA, you are exposing yourself to deal risk.
In the past year or so, some big deals fell through, according to IndexIQ, such as when Husky Energy dropped its takeover bid for MEG Energy earlier this year. That impacts returns, and year to date, MNA hasn’t really delivered much to investors in total returns.
