The recent spate of splashy corporate mergers and acquisitions deals point to a banner year in M&A activity—nearly $300 billion worth of deals have already been announced worldwide this year, according to Reuters. The last time M&A activity was this hot was in 2007, when roughly $3.5 trillion in deals were completed. 

Solid corporate fundamentals are a big reason for the uptick in 2013. “Many firms have large cash positions and there is still a lot of perceived value out there,” says Steve Sachs, head of capital markets at ProShare Advisors.

In addition, a number of deals are coming from private equity firms with wads of cash they need to put to work. According to Paris-based investment advisor Triago, private equity firms must spend more than $100 billion by the year-end or else redeem those funds back to their investors. These firms, along with other potential acquirers, also can borrow funds at rock-bottom interest rates.

In 2007, the gonzo M&A market led to a banner year for “merger arb” traders who capitalize on—or arbitrage—the spread between a proposed transaction price and the current trading price.

Alternative Assets

This time around, traders and investors can employ several exchange-traded products that have sprouted up to replicate the merger arb strategy. These exchange-traded funds and exchange-traded notes buy shares of the target company after an announcement, and often apply a hedge by shorting the purchaser or the market via index puts.

Merger arb funds tend to have a beta below 0.5, meaning they theoretically should move roughly half as much as the overall market as embodied by S&P 500 (which has a beta of 1).

As a result, these funds are less about delivering market-beating returns and more about delivering gains with a lot less market risk and volatility.

“Investors like to use the merger arb funds as part of a broader asset allocation strategy,” says Adam Patti, CEO of Index IQ, which launched the IQ Merger Arbitrage ETF (MNA) in late 2009. “They are included in the part of portfolios dedicated to alternative assets.”

These funds underperformed the broader market during the past few years when the pace of deal making was slow and their market hedging activity blunted the upside potential. For example, MNA has risen just a few percentage points since its inception more than three years ago.

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