Merge and Acquisition arbitrage is a traditional and classical strategies been well utilized by many fundamental hedge fund managers such as greenbelt and John Paulson. Quant hedge funds have been exploiting these phenomena – price discrepancies before and after the occurrence of acquisitions – using systematic quantitative models, reaping in handsome profits. In addition, these strategies isolate return from a broad market, providing diversification and orthogonal performance to the whole portfolio of investors. Astute ETF creators, Indexers certainly see the immense opportunities in packaging it into passive fund format too. Hence, two M&A ETF are already in the market: MNA and MRGR.
MNA, IQ Merger Arbitrage ETF, issued by IndexIQ, now affiliated to New York Life Investment, issued this fund early in November 2009, accumulating $206 million assets as of May 2017. The underlying index is IQ Merger Arbitrage Index. The universe of eligible Index Components includes the following deal types: Acquisition; Merger; Leveraged Buyout; and Private Equity. Minority Interests, Unit Divestitures, Target Ownership (private, division/unit), State Owned, and Joint Ventures are excluded. Eligible deal types must also have greater than 50% ownership sought by the acquirer. The index is comprised of common stocks and exchange traded funds (ETFs). It calculates a probable scenario for each deal type within the Index. Eligibility List as per the following rules-based methodology (referencing the IQ Merger Arbitrage Index Methodology):
Cp = Close Price of security 1 day prior to Monthly Rebalance Date
Ap-1 = Close Price of security 1 day prior to deal announcement date
Op = Offer Price of security on deal announcement date
Probability = (Cp – A p-1) / (Op – Ap-1)
Six scenarios are broken down, each is designated a probability, upon which, top ones are selected or considered to be included in the monthly reconstitution list.
MRGR, The ProShares Merger ETF, tracks S&P Merger Arbitrage index, issued to the market in December 2012 by ProShares, the assets under management stays flat, $2.68 million. It asks an expense fee of 0.75%, slightly lower than that of MNA’s 0.77%. This index is comprised of stocks currently involved in pending mergers. There are about 40 hodling companies that are currently considered as acquiring targets in merger deals. Factors such as size, liquidity, premium and exchange listing are also factored in to ensure that the underlying positions are tradable and offer upside potential even if the deal does close.
Now let’s compare their performance. Obviously these two funds underperformed compared to the market, however, the reason cannot simply be attributed that Merge & Acquistion strategy doesn’t work, the intricacies and complexities of constructing an index/ETF put a high hurdle, which also means clever indexers may be able to overcome it and come up with an effective product.