Deal Activity At 7-Year High: Merger ETFs In Focus [IndexIQ IQ ARB Merger Arbitrage ETF]

deal handshakeMerger and acquisition activities are at their seven-year peak thanks to the still-accommodative monetary policies in the major parts of the developed world. Borrowing costs remain easy on the pocketbook, while cash reserves are heavy for most of the big corporations across the world.

To add to this, a slowly improving market sentiment and benign financing terms have helped the space to shore up this year. Market consolidation is the name of the game now. As per Reuters, year-to-date global deal volumes as of June 26 increased 75% year over year to $1.75 trillion.

The agency noted that the search of tax havens and accessibility of cash held in overseas markets prompted U.S. companies to cut deals with foreign companies. Market experts expect this spell to continue at least for the rest of the year given no major shift in the global economy.

Notably, the second quarter of this year was the busiest with respect to deals, since the second quarter of 2007. The deal volume in Q2 scaled up considerably from $680 million in the first quarter of 2014.

Cash rich companies like Pfizer Inc, Comcast Corp and General Electric Co. led the way for Q2 activities, with the healthcare sector striking the maximum deals as noted by Reuters.

Media and entertainment followed the trend with deal talks between heavyweights Comcast and Time Warner Cable as well as AT&T and DIRECTV on the table (read: 3 ETFs to Watch on Comcast-Time Warner Cable Deal).

How to Play?

Investors could earn dollars from this flurry of deals by using the merger arbitrage strategy in their portfolios. This strategy looks to tap the price differential (or spread) between the stock price of the target company after the public announcement of its proposed acquisition and the price offered by the acquirer to pay for the stock of the target company.

Basically, this differential takes into account the uncertainty factor that the deal might not materialize. If it does, however, investors generally enjoy some quick gains and if it doesn’t, they face the risk of some losses.

A simple merger arbitrage strategy would be to take opposite positions (long/short) in the stocks of the target and acquiring company. However, what position to take in which company would depend entirely on an investor’s perception on the deal.

ETF Impact  

Below, we have highlighted two merger arbitrage ETFs which could entice investors following a surge in deal volumes. Investors should also note that these ETFs bear low correlation with broader markets, thus providing some cushion against broader market sell-offs (read: Buy These Uncorrelated ETFs in Rocky Markets).

IQ Merger Arbitrage ETF (NYSEARCA:MNA)

This fund offers capital appreciation by investing in global companies for which there have been public announcements of a takeover while at the same time providing short exposure to global equities as a partial equity market hedge. The strategy is accomplished by tracking the IQ Merger Arbitrage Index.

The fund invests about $38.8 million in 62 holdings putting the largest allocation to Morgan Stanley ILF/TREAS/INST, Hillshire Brands and DIRECTV on the long side.

Costs come in at 77 basis points a year. As far as risk-quotient is concerned, MNA has an R-squared of 17.5%, volatility of 9.48% and beta of 0.24%. The ETF has added about 4.5% year-to-date (as of July 7, 2014).

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