Why It’s Merger Arbitrage Season and How to Invest
In tough economic times, large-cap companies are often better positioned to weather the tough environment than smaller ones, providing increased opportunity for long-term mergers and acquisitions.
While historically mergers have decreased in frequency during economic downturns, the Fed is currently anticipating a soft landing in this tightening cycle, while positioning itself to capture the recovery. Capturing an alternative revenue stream from global corporate mergers and acquisitions could bring many benefits to a portfolio.
“Given the market sell-off in 2022, large-cap companies with deep pockets are likely to have many candidates to consider buying. Merger arbitrage strategies give advisors the opportunity to benefit from this trend without taking too much risks,” says Todd Rosenbluth, head of research for ETF Trends.
Mergers and acquisitions, while not as common in a downturn, have been shown to produce outperformance of the acquiring company in an economic downturn, according to an article in Harvard Business Review, written in 2020 at the height of COVID-19-related economic lockdowns and shutdowns.
The study assessed companies during the global financial crisis between 2007 and 2009 and found that there is a very small window of highest value between economic downturn and recovery, where mergers and acquisitions happen quickly as companies with cash and assets quickly seize lucrative opportunities. Investors who are already positioned to enter merger arbitrage could greatly benefit from such an environment.
Merger Arbitrage Explained and the Investment Opportunity
Merger arbitrage is a way to seek capital appreciation while being uncorrelated to stocks and bonds. It works by investing in the shares of a company being acquired and seeks to capture and capitalize on the difference between the current share price and the amount the acquisition will buy.
Digging a little deeper, merger arbitrage strategies can focus on the likelihood of an acquisition or merger occurring, the timing in which it will occur, and other factors, and then seek to maximize those estimates. It carries a level of risk generally mitigated by options and offers an opportunity for portfolio diversification.
the IQ Merger Arbitrage ETF (MNA) seeks to track the IQ Merger Arbitrage Index, an index that tracks global companies that have announced their involvement in mergers, acquisitions, or other buyout-related transactions.
The index attempts to capitalize on the price difference between a target company’s current stock and the price paid once the buyout is complete. It also includes short positions in US equity markets and non-US equity markets as per the prospectus. Under certain conditions, such as when there are not enough target companies for takeovers, when there is not enough cash in the target company, or when target companies are deleted between monthly replenishments, the The underlying index will allocate these funds to either US Treasuries or short-term bond ETFs.
MNA has an expense ratio of 0.77% and the top sector exposures are currently Information Technology at 20.9%, Consumer Discretionary at 10.5% and Communication Services at 9.2%.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.