Some high-profile buyout deals have been falling apart lately.
For instance, the third largest U.S. wireless carrier Sprint (NYSE:S) just announced it would end its bid to acquire rival T-Mobile (NYSE:TMUS), the number four carrier, because of staunch resistance from regulators. Media giant 21st Century Fox (NYSE:FOXA) ceased its pursuit of Time Warner Cable (NYSE:TWC) because the two simply couldn't agree on a buyout price. A recent takeover attempt involving the big pharmaceutical firms Pfizer (NYSE:PFE) and AstraZeneca (NYSE:AZN) also went nowhere after the latter backed out at the last minute.
These and other big deals gone sour have been getting plenty of media attention, possibly giving the impression that M&A activity is weakening. But that couldn't be further from the truth.
According to software firm Dealogic, which offers multiple services including M&A analytics, failure rates for M&A deals have been falling since last year and are near pre-recession levels. What's more, global M&A volume has reached nearly $2.3 trillion this year, a 43% year-over-year increase and the second-highest yearly total ever (after $3.1 trillion in 2007).
And it looks like there's plenty more to come.
In a second-quarter letter to shareholders, legendary investor Jeremy Grantham predicted the greatest M&A boom ever. "I think it is likely (better than 50/50) that all previous deal records will be broken in the next year or two," he wrote. "If I were a potential deal maker, I would be licking my lips at an economy that seems to have enough slack to keep going for a few years."
Those are statements to heed given the reputation of Grantham, chief investment strategist at GMO, the Boston-based asset management firm he co-founded in 1977. Since then, he has earned a spot among investing's all-time greats with, among other things, an uncanny ability to spot asset bubbles. He's called all the major ones of our time, including the Japanese stock bubble of the late 1980s, the dot-com bubble of the late 1990s and the 2008 housing bubble.
So what's that connection between M&A and asset bubbles? Well, in this case, Grantham expects the former will lead up to the latter, although, as his comments suggest, this could take up to a few years.
In the meantime, there are catalysts galore for an M&A boom of historic proportions, and Grantham cites about half a dozen: low interest rates, relatively high profit margins, the economy being in a relatively early-stage recovery, massive labor reserves and plenty of room for growth in capital spending.
Other analysts also pointed out that, because of high stock prices, it's often cheaper for companies to make acquisitions than buy back stock. Plus, many companies have accumulated immense cash hoards and, with the economy seemingly on the mend, are becoming more likely to take some risks with their cash rather than just sitting on it.
Thus, it seems there's a clear opportunity for investors to profit from dealmaking during the next couple years or so. The question is how best to do it.
Since it's virtually impossible for individual investors to keep up with all the M&A activity going on and be able to separate fact from rumor, they're better off leaving the task to mutual funds and/or exchange-traded funds (ETFs) designed to capitalize on such activity. There are a couple options worth considering.
A top choice -- and one that happens to have outperformed 95% of its peers during the past decade -- is a mutual fund called Merger Investor (MERFX). Like most funds focused on M&A, MERFX uses a merger-arbitrage strategy in which it buys the stocks of takeover targets and shorts the stocks of the companies doing the buyouts. This is because the stock of a company being acquired usually goes up, whereas the acquiring firm typically sees its stock fall.
MERFX usually allocates at least 80% of fund assets to M&A (but will try to capitalize on reorganizations and bankruptcies to some extent, too). According to Morningstar, the fund devotes a big chunk of its research budget to law firms and other outside experts to learn as much as possible about potential deals and their chances of actually being inked.
Investors who prefer ETFs should consider the IQ Merger Arbitrage ETF (NYSE:MNA), which tracks an index of companies that have announced they're being acquired. But rather than shorting the stocks of the acquiring firms, the fund simply shorts broad domestic and international stock indexes (the S&P 500 and MSCI EAFE) as a partial equity hedge.
Not pairing up long and short positions like MERFX hasn't affected long-term performance, though. The fund's three-year record is actually slightly better than MERFX's.
There's also the Credit Suisse Merger Arbitrage Liquid ETN (NYSE:CSMA), an exchange-traded note that, like MERFX, is long buyout targets and short the acquiring firms. However, results indicate the fund hasn't employed merger-arbitrage nearly as effectively. Indeed, none of the investments I've described have has posted exciting returns lately, but that could change dramatically if M&A picks up like Grantham predicts.
|Heading||YTD||1 year||3 year||5 year||10 year|
|Merger Investor (MERFX)||1.9%||4.0%||4.0%||3.5%||3.9%|
|IQ Merger Arbitrage ETF (MNA)||2.9%||4.7%||5.5%||N/A||N/A|
|CS Merger Arbitrage Liquid ETN (CSMA)||-3.7%||-2.7%||0.1%||N/A||N/A|
Risks to Consider: Considering the long-term performance of merger-arbitrage-focused investments, it's possible their strategy may not be capable of market-beating returns. Also, Grantham sees M&A eventually pushing the stock market up to "true bubble levels."
Action to Take --> If you're intrigued by Grantham's assessment of M&A activity, consider targeting the potential boom with one or more of the investments I've described. Splitting your M&A allocation equally between MERFX and MNA might be the best option, since they're both solid performers and you'd get equal amounts of actively managed and passive index approaches. Or, if Grantham is right about the run-up to a bubble, simply tracking the market may prove an even better way to reap the rewards of the M&A surge -- if you manage to get out before the big pop.
P.S. Are you terrible at knowing when to sell? You're not the only one. Fortunately, a former trust fund manager created a two-part blueprint that reveals when to sell... and when to buy. It's been 85% accurate for over four years -- and just closed out a 70% gain. Click here to access it now.
Mutual Funds & ETFsThese three transportation funds attract the majority of sector volume.
Investing BasicsA look at two different trading strategies for ETFs - one for investors and the other for active traders.
Mutual Funds & ETFsDiscover detailed analysis and information about some of the top exchange-traded funds (ETFs) that offer exposure to the investment-grade corporate bond market.
Mutual Funds & ETFsFind out which emerging markets ETFs have enough of an asset base, trading volume and low fees to be considered top choices in the segment.
Mutual Funds & ETFsVolatility funds offer exposure to high greed and fear levels while avoiding predictions on price direction.
Mutual Funds & ETFsWe look at the best currency ETFs for gaining exposure to various global currencies, based on daily volume and performance.
Chart AdvisorNews out of Alcoa is causing active traders to turn toward base metals for opportunities. Before diving into the market, check out the charts of these three ETFs.
Mutual Funds & ETFsLearn about the top three exchange-traded funds (ETFs) that invest in sovereign and private bonds issued by Germany with different duration yields.
Mutual Funds & ETFsInstead of selling your stocks to get gains, consider a short selling strategy, specifically one that uses short ETFs that help manage the risk.
Investing BasicsBonds can be a great addition to a portfolio but be aware of these four myths.
Mutual funds can invest in initial public offerings (IPOS). However, most mutual funds have bylaws that prevent them from ... Read Full Answer >>
The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
Asset management utilizes two main investment strategies that can be used to generate returns: active asset management and ... Read Full Answer >>
Wash trading, the intentional practice of manipulating a stock's activity level to deceive other investors, is not a legal ... Read Full Answer >>
There are many exchange-traded funds (ETFs) that track the retail sector or elements of the retail sector, and some of those ... Read Full Answer >>