Currently, about 20 percent of the portfolio is hedged. Patti notes that he sees this ETF playing the role as an equity hedge. When the broader market falls, the short position appreciates in value. The price of shares owned may also decline, but there’s a limit to the downside because the price is unlikely to fall too far from the deal’s target value. That’s particularly the case for all-cash deals, Patti says, adding that limits the fund’s volatility to be about one-third of the S&P.
The MRGR fund is based on the S&P Merger Arbitrage Index. It buys up to 40 companies from developed markets that are current takeover targets, while it sells the companies that are the acquiring firms if stock is included in the offer. Deals are screened for size and liquidity, with target companies initially included in the index at a 3 percent weight. Companies that are shorted are weighted between zero and 3 percent, depending on how much stock is offered in the deal. About 25 percent of the portfolio is hedged.
The fund adds deals two days after an announcement is made and removes deals if they are older or performing poorly. Its top three holdings include Yadkin Financial, Starz and PrivateBancorp. It also has a currency-hedge component.
MNA is up about 2.5 percent year-to-date, while the ProShares fund is down 1 percent. The SPDR S&P 500 ETF (SPY) is up 5.87 percent, so both funds are lagging the broader market. With one exception, the funds lag the broader market over the long-term, too. On a one-year basis, MNA is up 5.27 percent, while MRGR is down 1.48 percent, while over a three-year basis MNA is up 3.08 percent and MRGR is down 0.39 percent. MNA’s five-year average is 3.4 percent. Comparatively, SPY’s one-year, three-year and five-year track records are 4.44 percent, 8.71 percent and 13.44 percent, respectively.
There are two mutual fund products that also seek to piggy back merger activity, the Merger Investor fund (MERFX), which has $3 billion in assets and an expense ratio of 1.34 percent and is up 1.24 percent year-to-date, and the Gabelli ABC AAA (GABCX), with an expense ratio of 0.59 percent and it is up 1.49 percent. MERFX’s one-year return is 0.99 percent, the three-year is 0.88 percent and the five-year is 2.02 percent. GABCX’s one-year return is 1.34 percent, the three-year is 1.75 percent and the five-year is 2.87 percent.
Patti says any hedge strategy will lag the broader market when it is in a bull market, as the S&P generally has been. He says the ideal time for a hedge strategy is when the broader market is weaker. For instance, on Nov. 1 when SPY was down 1.06 percent, MRGR was flat, and MNA was up 0.38 percent, he says.
Todd Rosenbluth, director of ETF and mutual fund research for CFRA, says these merger ETFs can act as a hedge against the broader market, and he calls them an “interesting way to play the M&A boom.”
But Rosenbluth says he wonders if investors would not be better served by trying to anticipate which industry might be facing consolidation, which allows the investors to participate in the gains if companies are acquired.
“That would allow you to try and get in front of the M&A instead of responding to activity. Even though we’ve seen an increase in M&A activities, these ETFs are essentially flat,” he says. “We think there are better ways to play the market … with a more diversified traditional fund for upside growth.”