Merger arbitrage fund follow-up

• abnormalreturns
• August 30th, 2010

Late last year we wrote a post on the launch of the IQ Merger Arbitrage ETF (MNA).  At the time we were somewhat skeptical that the fund’s strategy got at the true nature of merger arbitrage.  We described it as “arbitrage-free merger arbitrage.”  Today the fund gets some (much needed) attention from John Spence at WSJ.  Spence writes:

An exchange-traded fund that specializes in merger arbitrage has received a lukewarm reception in the market, but a burst of deal activity may invite some investors to take a closer look.

According to the article the fund has yet to catch on with investors with some $30 million in assets under management.  The fund’s open-end competitors, the Arbitrage Fund (ARBFX) and the Merger Fund (MERFX), have over time succeeded in gathering assets from investors (and advisers) interested in merger arb-like strategy returns.

Merger-arb profits play out over a longer time frame and tend to benefit a portfolio through their lower correlations and volatility.  To benefit from both of these effects requires a longer time horizon.  In addition, both funds are better able to engage in true merger arbitrage by taking short positions in the stock of the acquiring company.  Below one can see how the IQ Merger Arbitrage ETF has performed compared to its open-end competitors and the S&P 500.

Source:  StockCharts.com

So what do these roughly nine months of performance tell us?  Frankly, not a lot.  Performance between the three merger-focused funds has been similar.  Two things do stand out.  First, all of the merger-focused funds are substantially less volatile than the S&P 500.  Second, but less so, the merger ETF is more volatile than the open-end mutual funds.  This may be due to our earlier point about more precise hedges.

We are not convinced that the ETF structure is best to conduct true merger arbitrage.  However if an M&A boom is coming down the road don’t be surprised if investors line up to invest in a fund with “merger” in the title.

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