ETF Edge

Wall Street firms expect more deals in 2019—how to profit from the merger madness

How to profit from the merger madness

Merger mania is alive and well on Wall Street.

A slew of top firms including J.P. Morgan, Deloitte, Morgan Stanley and PwC have predicted that 2019 will continue to see strong deal activity after a banner 2018, when global merger and acquisition activity posted over $4 trillion in volumes.

Several megadeals have already hit the market in the first half of 2019, including Bristol-Myers Squibb's purchase of Celgene, the largest health-care deal on record when you factor in the debt load, according to data gathered by Refinitiv.

And — you guessed it — there's a way for investors to try to capitalize on upcoming deals — using an exchange-traded fund from IndexIQ called the IQ Merger Arbitrage ETF, ticker MNA.

MNA's strategy is rules-based, says Salvatore Bruno, the man behind the ETF and IndexIQ's chief investment officer. Speaking on CNBC's "ETF Edge," he said the general idea behind the ETF is investing in large deals expected to generate high premiums ahead of their completion, giving investors "the opportunity to pick up some of those premiums."

Typically, this ETF's overseers wait until deals are announced, then buy the target company, providing it meets their criteria. Under the Trump administration, deal completion rates have only gone up, making that piece of MNA's strategy stronger, Bruno said Wednesday.

"By owning approximately 40 to 50 names at any point in time, we're trying to diversify some of that specific risk of one particular deal breaking, but, really, trying to capture the overall premium associated with merger arbitrage investing," he said.

The fund also has a unique short-selling strategy, Bruno said. Rather than shorting the stock of the acquirer, like in a typical merger arbitrage strategy, MNA shorts the acquirer's sector as a whole.

"We're trying to provide broad protection against downside moves related to a specific event in an industry, a sector or the broad market," Bruno said, adding that Wednesday's choppy, negative trading in the broader market didn't end up putting much pressure on his fund, which is roughly 35% hedged against broad market weakness.

"MNA has all of the benefits of a traditional ETF, including transparency, liquidity and tax efficiency, so that's why we think it's actually the preferred vehicle for a strategy like this," said Bruno, who is also managing director at New York Life Investments. "It's actually been fairly effective at protecting against the broad downside moves."

In addition to Celgene, MNA's top holdings include oil and gas company Anadarko Petroleum, which is in the process of being acquired by Occidental Petroleum, and software play Red Hat, which was bought by IBM last October.

While MNA's performance has essentially been flat for 2019, it's hedged especially well against the U.S.-China trade debacle, Bruno said.

"Even though we have probably about a 25% weight in technology, we're actually short about 12% on the technology sector," he said. "As we've seen some of the semis come under pressure with the China trade issues, ... that's actually provided very good downside protection ... against that broad, down move that's affecting the entire sector."

All in all, Bruno's thesis is simple: "For an individual investor, it would probably be pretty difficult to own 40 or 50 deals and then to identify the hedges and to put those on," he said. "Clearly, doing it in a structure like an ETF gives you that diversification."