The Shrinking Pool of Equities and What This Means for Investors

by: , Chief Investment Officer and Managing Director | IndexIQ

One major side effect of the M&A boom and a multi-year slowdown in Initial Public Offerings (IPOs): fewer public companies.

In fact, the number of U.S.-listed companies has fallen by more than 3,000 from a peak of 9,113 in 1997, according to the University of Chicago’s Center for Research in Security Prices.1 IPOs are down, too, with just 128 for all of 2016, the lowest number since the financial crisis, according to an article in Fortune Magazine earlier this year.

M&A activity is contributing to the decline as well, with nearly $600 billion in deals done in 4Q 2016, according to Dealogic. A KPMG study indicates that 84% of companies surveyed expect to initiate a deal through 2017, and 78% of those respondents are eyeing multiple deals.2 During this period, private financing has ballooned, creating opportunities for companies to raise capital without the need to tap the public markets – think Uber or Airbnb.

So, what does this mean for investors? Most of us don’t have a simple way to access the large pools of private capital that are going into these companies. But, that changes when it comes to those public companies being taken private by a private equity firm, or combining through a merger.

Trying to guess the next big takeover target is not usually a fruitful exercise, however. More effective – and more predictable – is a strategy that seeks to benefit from the gap that often opens up between the price an acquirer announces it will pay for a company and the cost of the shares of the target company in the open market. This strategy is known as “merger arbitrage.” Why would a company’s shares not move immediately to the proposed deal price when a takeover is announced? Sometimes, they do. In other instances, when the market judges the offer to be too low and another bidder is expected to appear, the shares might go to a premium to the offer.

But, in many cases, the shares of the target will trade at a discount to the proposed purchase price. There are lots of reasons why this might happen: concern over the buyer’s ability to fund the deal; the possibility of regulatory or anti-trust challenges delaying or preventing the deal from closing; or stock price fluctuations in a stock-for-stock transaction, to name a few. Generally speaking, this gap tends to narrow as the closing date nears, and disappears entirely when the deal is completed. The merger arbitrage investor looks to capture the return generated as the offer price and closing price come together, a relatively low-risk way of participating in M&A.

It’s an interesting time in the investing world – Bloomberg data reveal that there are now actually more market indexes in circulation than there are U.S. stocks. But, while the number of stocks in the public domain may be declining, the opportunities are still there. A merger arbitrage strategy is one approach that can help position an investor to take advantage of the prevailing trends.

1. Farrell, Maureen, “America’s Roster of Public Companies Is Shrinking Before Our Eyes” The Wall Street Journal, Jan. 6, 2017.

2. Tiemann, Daniel, “M&A Pulse: M&A experts weigh in on deals for 2017” KPMG LLP, 2017.

About risk:

All investments are subject to market risk and will fluctuate in value. Alternative investments are speculative, entail substantial risk, and are not suitable for all clients. Alternative investments are intended for experienced and sophisticated investors who are willing to bear the high economic risks of the investment. Investments in absolute return strategies are not intended to outperform stocks and bonds during strong market rallies. Hedge funds and hedge fund of funds can be highly volatile, carry substantial fees, and involve complex tax structures. Investments in these types of funds involve a high degree of risk, including loss of entire capital. Treasurys are backed by the full faith and credit of the Federal government, as to the timely payment of principal and interest.

Merger arbitrage involves simultaneously purchasing and selling the stocks of two merging companies to create “riskless” profits and is often considered a hedge fund strategy.

The information and opinions contained herein are for general information use only. IndexIQ does not guarantee their accuracy or completeness, nor does IndexIQ assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are as of the date of this report and are subject to change without notice. Past performance is no guarantee of future results.

MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. IndexIQ® is an indirect wholly owned subsidiary of New York Life Investment Management Holdings LLC. ALPS Distributors, Inc. (ALPS) is the principal underwriter of the ETFs. NYLIFE Distributors LLC is a distributor of the ETFs and the principal underwriter of IQ Hedge Multi-Strategy Plus Fund. NYLIFE Distributors LLC is located at 30 Hudson Street, Jersey City, New Jersey 07302. ALPS Distributors, Inc. is not affiliated with NYLIFE Distributors LLC. NYLIFE Distributors LLC is a Member FINRA/SIPC.

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Salvatore J. Bruno

Chief Investment Officer and Managing Director | IndexIQ

Sal is Chief Investment Officer at IndexIQ, where his primary responsibility includes developing and maintaining the firm’s investment strategies. Sal joined IndexIQ in 2007 from Deutsche Asset Management (DeAM) where he held a number of senior positions

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