So far this year, mergers and acquisitions have been lackluster, with U.S. transaction volume falling a whopping 60% to date.
But this might just be a temporary lull. As I pointed out in a recent piece, it looks like M&A is poised for a rebound. Some of the factors that could spur the comeback include rock-bottom interest rates, continued strength in the U.S. economy and $1.4 trillion on corporate balance sheets. But perhaps the biggest factor is the bull move in the stock market so far this year, which shows confidence is returning.
If M&A does stage a rebound, merger funds are a good way to play it. This type of investment uses a strategy known as arbitrage, or merger arb, which involves investing in announced mergers. Because there is a long lag time until a deal closes — which easily can span six months or more — the stock price of the buyout target usually is at a discount to the offer. The reason? There’s a risk the deal might fall through. And this small difference essentially is the profit for a merger fund.
So let’s take a look at three merger arb funds to play an M&A rebound:
The Merger Fund (MUTF:MERFX) is a pioneer in the industry, getting its start in 1989. But the ol’ boy hasn’t lost its edge. During the past 10 years, the fund has posted an average annual return of 3.48%. While that seems meager, it’s a decent track record, keeping up with the S&P 500 but with less volatility.
However, MERFX isn’t without its risks. The fund’s original manager, Fred Green, departed at the end of 2010. But the new managers — Roy Behren and Michael Shannon — have strong backgrounds. But perhaps the biggest issue is that MERFX has a hefty $5.1 billion in assets, so the portfolio managers might have difficulties putting the money to work, considering the limited amount of profitable deals.
Gabelli ABC AAA
When it comes to M&A investing, Mario Gabelli is one of the best. He has been focused on the market since the mid-1970s and has a knack for understanding dealmaking in industries like media and technology.
Gabelli manages the Gabelli ABC AAA Fund (MUTF:GABCX), which has $517 million in assets. While the fund’s turnover ratio of 276% seems high, it is common for the industry, considering that arb investing usually is about taking short-term positions.
The Gabelli fund also looks for investment opportunities beyond arb plays — for example, purchases of cheap stocks that ultimately might become buyout opportunities.
The strategy has been a winner. GABCX’s average annual return is 4.31% during the past decade.
IQ Merger Arbitrage ETF
The IQ Merger Arbitrage ETF (NYSE:MNA) is based on the IQ Merger Arbitrage Index, which is a computer model focused on announced deals across the world. To balance out the volatility, the index also has some short positions in stocks.
The IQ Merger fund is fairly new, having launched in November 2009. While the returns have been lackluster through 2011, the recent performance — up 4.11% in 2012 — has been encouraging.
Some of the top holdings include El Paso (NYSE:EP), Goodrich (NYSE:GR) — whose buyout by United Technologies (NYSE:UTX) was approved by UTX shareholders Tuesday — Illumina (NASDAQ:ILMN) and Motorola Mobility Holdings (NYSE:MMI).
Tom Taulli runs the InvestorPlace blog IPO Playbook, a site dedicated to the hottest news and rumors about initial public offerings. He also is the author of “The Complete M&A Handbook”, “All About Short Selling” and “All About Commodities.” Follow him on Twitter at @ttaulli or reach him via email. As of this writing, he did not own a position in any of the aforementioned securities.