IndexIQ recently introduced the IQ ARB Merger Arbitrage ETF (NYSE: MNA) intended to track the IQ ARB Merger Arbitrage Index. With this fund, Index IQ hopes to provide a low cost way for investors to gain exposure to merger arbitrage investing, but have they succeeded?
In a merger or acquisition, the company being acquired usually trades at a discount to the deal price. An arbitrage trader will buy the company being acquired and, if the deal is a stock swap, sell the acquiring company short. As long as the deal goes through as announced, the trader captures the discount spread.
An example of a cash merger arbitrage opportunity is the Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) purchase of Burlington Northern Santa Fe (NYSE: BNI) for $100 per share. Burlington Northern recently closed at $98.66. Investors purchasing Burlington Northern could make $1.34 per share plus pick up a dividend payment if the deal goes through as announced.
The underlying index for MNA is made up of long positions in stocks that are the subject of takeover announcements. The stocks can trade on any number of exchanges around the world. The index hedges market exposure by holding at least two inverse or ultra-inverse ETFs. Significantly, there is no mention of shorting acquiring company stocks. Index IQ charges a 0.75% annual fee for the IQ ARB Merger Arbitrage ETF and the fund rebalances positions every month.
As of Dec. 4, the top holdings for IQ ARB Merger Arbitrage Index and the ETF were:
|
Component
|
Index Weight %
|
ETF Weight %
|
|
iShares Barclays Short Treasury Bond Fund (NYSE: SHV)
|
12.76
|
N/A
|
|
Cash
|
N/A
|
20.23
|
|
Starent Networks Corp. (Nasdaq: STAR)
|
8.15
|
8.19
|
|
Sun Microsystems Inc. (Nasdaq: JAVA)
|
7.07
|
7.11
|
|
BJ Services Co. (NYSE: BJS)
|
7.02
|
7.06
|
|
Cadbury
|
5.9
|
5.93
|
|
Burlington Northern Santa Fe
|
5.65
|
5.68
|
|
Affiliated Computer Services
|
5.61
|
5.64
|
|
IMS Health
|
5.37
|
5.40
|
|
Marvel Entertainment
|
5.25
|
5.28
|
|
Proshares Ultrashort S&P 500
|
4.92
|
N/A
|
|
Ultrashort MSCI EAFE Proshares
|
4.76
|
N/A
|
|
Varian Inc.
|
4.38
|
4.41
|
|
MPS Group Inc.
|
4.31
|
4.33
|
Souce: IndexIQ.
Two things jump out from the holdings. The fund currently carries a lot of cash, and the index equity hedge from the short ETFs isn't represented in the fund itself. The fund does hold futures to gain short exposure.
By not shorting acquiring companies, the fund excludes half of the classic "short the acquirer, long the target" trade investors associate with merger arbitrage and leaves market risk in the trade. The long target positions match the index well, but the large cash position doesn't support the ETF objectives.
While providing a low cost merger arbitrage vehicle for investors may be a noble goal, Index IQ has missed the mark with this fund.
The original version of this article did not mention that the fund uses futures to gain short exposure. We regret the omission.
More on mergers and arbitrage:
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