While investment bankers and C-suite executives may rake in huge sums from deals, forget high returns through merger arbitrage ETFs, though. When used properly, the idea, co-opted from the hedge fund world, is designed as a market hedge to generate returns uncorrelated to the overall direction in equities and bonds.
For example, the S&P 500 had logged an 8.6 percent through the end of August, according to Morningstar, compared to a 3.85 percent return for the IQ Merger Arbitrage ETF.
The returns have been muted during the extended bull market run. The IQ Merger Arbitrage Index, which has been in existence longer than the ETF, had returned 4.22 percent over a five-year time span through Aug. 31, compared to 92.5 percent for the S&P 500.
ProShares Merger ETF had lost close to 2 percent so far this year through Aug. 31.
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But Morningstar ETF analyst Robert Goldsborough described these ETFs as offering "bondlike returns" and said as a result it's best to compare returns to three-month T-bills.
The goal is portfolio diversification and volatility reduction, not shoot-the-lights-out returns, said Neena Mishra, director of ETF research for Zacks Investment Research.
David Fabian, a managing partner at FMD Capital Management in Irvine, California, said these ETFs should comprise at most 5 percent of an investor's portfolio. But Fabian thinks investors are better off sticking with sector ETFs—specifically, cash-rich sectors where deal activity is likely to happen, for example, right now in health-care. That's not a market hedge bet, like the merger ETFs, but a straight trade on stock prices going up in a sector based on an expected wave of M&A.