Merging ETFs and Merger Arbitrage

by: , Director, Product Management, IndexIQ

Global merger and acquisition (M&A) activity hit a 17-year high in the first quarter of 2018, according to Mergermarket. In aggregate, there were nearly 3,800 deals—totaling $891 billion—over the first three months of the year. And this trend could continue as the year progresses, given improving corporate cash flows and greater clarity on the regulatory front. Investors can access the opportunities from increased M&A activity through merger arbitrage strategies.

Merger Arbitrage in Action

In short, merger arbitrage is a strategy that seeks to profit from the price discrepancy between a stock’s price after the public announcement of a merger and the completion of the deal. The chart below demonstrates merger arbitrage in action. When a merger is announced, the stock price of the company being acquired typically rallies in response to the offer. However, the higher price usually remains below the takeover bid. This “discount” represents the risk associated with the deal not closing—whether it’s due to problems obtaining shareholder approval or financing, regulatory issues, or other factors. As the deal moves closer to its consummation, the spread typically narrows, as the risk dissipates. When successful, a merger arbitrage strategy benefits by purchasing companies below the target price and locking in the difference (spread).

Source: The above is for illustrative purposes only, based on hypothetical events of an actual merger and acquisition.

Benefits of Merger Arbitrage

In addition to capitalizing on the spread, there are a number of other potential benefits associated with a merger arbitrage strategy.

A Smoother Ride: Merger arbitrage strategies have historically generated relatively stable returns across various market environments. This is partially because the M&A deal is typically unrelated to fluctuations of the broader market. This may be an important consideration, given the recent increase in market volatility.

Rolling 12-Month Returns

Source: Morningstar, as of 3/31/2018. Past performance is not a guarantee of future results. It is not possible to invest directly in an index.

Less Risk: As shown below, merger arbitrage strategies have exposed investors to manage risk, as measured by standard deviation, than an investment in the S&P 500 Index, as well as various types of investment portfolios.

Source: Morningstar, as of 3/31/2018. Standard deviation is the measure of the dispersion of a set of data from its mean.

Diversification: Since merger arbitrage strategies are generally isolated from broader markets, they have a relatively small correlation to the S&P 500 Index and a negative correlation to the Bloomberg Barclays U.S. Aggregate Bond Index. As such, an allocation to this strategy may help to diversify an investor’s overall portfolio.

Correlation of IQ Merger Arbitrage Index to:

Source: Morningstar, as of 3/31/2018. Correlation is a statistic used to measure how two securities move in relation to each other. Past performance is not a guarantee of future results. It is not possible to invest directly in an index.

Merging ETFs and Merger Arbitrage

There are several ways investors can access merger arbitrage strategies, including hedge funds and mutual funds. Another opportunity is through an exchange traded fund (ETF) that focuses on this strategy. We’ve found that ETFs can offer a number of benefits versus more traditional approaches.

  • Less Expensive: ETFs typically have lower fees and expenses than mutual funds and hedge funds that employ a merger arbitrage strategy.
  • Tax Efficiency: Given the number of deals in which they participate and relatively short holding periods, merger arbitrage portfolios generally experience high turnover making, a mutual fund structure notably tax inefficient. An ETF provides a more tax-efficient structure for a merger arbitrage strategy and helps to limit an investor’s short-term capital gains exposure.
  • Competitive Results: A passive ETF removes many of the human behavioral investment biases that may play a role in active managers’ decisions, which historically, have helped merger arbitrage ETFs perform well compared to actively managed mutual funds that focus on this strategy.


Merger arbitrage offers several potential benefits for investors, including increased diversification and the potential ability to dampen the impact of rising market volatility. In addition, given its negative correlation to the overall fixed income market, a merger arbitrage strategy may also be an appropriate investment vehicle in a rising interest rate environment.

About Risk:

All mutual funds and ETFs are subject to market risk, including possible loss of principal. Diversification cannot assure a profit or protect against loss in a declining market.

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.

Neither New York Life Investment Management LLC, its affiliates, or representatives provide tax, legal, or accounting advice. Please contact your own professionals.

The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS and CMBS (agency and non-agency). The IQ Merger Arbitrage Index seeks to achieve capital appreciation by investing in global companies for which there has been a public announcement of a takeover by an acquirer. This differentiated approach is based on a passive strategy of owning certain announced takeover targets with the goal of generating returns that are representative of global merger arbitrage activity. The Index also includes short exposure to global equities as a partial equity market hedge.

The Standard & Poor’s 500 Index (S&P 500) is an index of 505 stocks issued by 500 large companies with market capitalizations of at least $6.1 billion and is seen as a leading indicator of U.S. equities and a reflection of the performance of the large-cap universe.

Merger Arbitrage (M&A) involves simultaneously purchasing and selling the stocks of two merging companies to create “riskless” profits and is often considered a hedge fund strategy.

Standard deviation is the measure of the dispersion of a set of data from its mean.

New York Life Investments is a service mark and name under which New York Life Investment Management LLC does business. New York Life Investments, an indirect subsidiary of New York Life Insurance Company, New York, New York 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, and NYLIFE Distributors LLC is a distributor of the ETFs and the principal underwriter of the IQ Hedge Multi-Strategy Plus Fund. NYLIFE Distributors LLC is located at 30 Hudson Street, Jersey City, NJ 07302. ALPS Distributors, Inc. is not affiliated with NYLIFE Distributors LLC. NYLIFE Distributors LLC is a Member FINRA/SIPC.


Dan Petersen, CAIA®

Director, Product Management, IndexIQ

Dan Petersen is a Product Manager at IndexIQ, responsible for developing actionable content as it pertains to the competitive landscape, analyzing fund usage in the latest market environment, and portfolio positioning for both individual portfolios and broader-based applications

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