For investors, the growth of the ETF industry has certainly been a blessing. Aside from accessing equities and bonds for dirt cheap, regular retail investors now have the opportunity to gain access to strategies that were once either too expensive or hard to reach. Historically, alternative assets have been very costly and almost impossible for the little guy to gain exposure to. With the ETF boom still going strong, new products have allowed individual retail investors the ability to access hedge funds, long-short strategies, 130/30 tactics and other areas of the market previously off-limits. Anyone with a brokerage account can now channel their own inner hedge fund manager. One of more interesting opportunities for retail investors than can be tapped via exchange-traded funds lies within the absolute return strategy of merger arbitrage.

Merger Arbitrage 101

At its core, merger arbitragesometimes called risk arbitrageis when investors seek to profit from the spread that occurs when an acquisition is announced and the final purchase price is set. Typically, when a buy-out deal is announced, there is some risk that the merger deal will not close on time, or if at all. Because of this slight uncertainty, the target company's stock will typically sell at a discount to the price that the combined company will have when the merger is closed. This discrepancy is the arbitrageur's profit .

An offshoot of merger arbitrage also involves shorting shares of the acquiring company. Generally, the firms doing the buying will often see their share prices fall when a deal is announced. This produces a bigger spread for the investor.

For example, company A offers $20 to buy firm B. B's stock price then falls to $19.50. A merger arbitrage investor will then buy company B's stock and, when the deal closes, pocket the 50 cents. While that might not seem like a lot of money, doing the strategy over several deals produces steady returns that are not correlated to any sort of market or business cycle. The best merger arbitrage investors are able to generate 5-7% returns year-in and year-outeven in down markets.

The obvious drawback is if the deal fails to close or get approved, the target firm's shares could plummet. This leaves the arbitrageur holding the bag and could result in big losses.

Gauging an individual deal's chances is a difficult and time-consuming endeavor. This is exactly why ETFs can be the perfect way to gain exposure to absolute strategy. Here's how to play it:

Credit Suisse Merger Arbitrage Liquid Index ETN /

Debuting in October 2010, the Credit Suisse Merger Arbitrage Liquid Index (CSMA) provides exposure to the investment strategy by taking long and short positions in announced deals within the United States, Canada and Western Europe. The ETN strictly focuses on firms involved in a deal, rather than buy-out potential. This means it provides a "true" merger arbitrage option for a portfolio.

Another appealing aspect of this fund is itsrelativelylow cost; CSMA charges a mere 0.55%, making it the cheapest offering among the merger arbitrage ETFs .

For those investors looking for a little more oomph from their M&A bets, Credit Suisse also offers a leveraged version, the Credit Suisse Leveraged Merger Arbitrage Liquid Index ETN (CSMB). This fund tracks the same index as CSMA at twice the daily performance.

IQ Merger Arbitrage ETF

The IQ Merger Arbitrage ETF (MNA) is the grandfather fund in the sector, debuting in 2009. Like CSMA/CSMB, MNA's underlying index provides exposure to domestic as well as global companies that have recently announced takeovers by another company. As a hedge, the fund will also take short positions in certain acquiring company's stocks.

The fund, however, is slightly more expensive than its competitor, with its expense ratio coming in at 0.76% .

ProShares Merger ETF

ProShares is mostly known by investors for its leveraged ETF products. However, the firm has been making strides into the strategy-based market; ProShares's latest is the ProShares Merger ETF (MRGR).

This fund tracks the S&P Merger Arbitrage Index and like the other funds on this list, it seeks to capitalize on the spread between stock prices of a target company after an M&A deal is proposed compared to the offering company. Like the ETFs we've been discussing, the ProShares fund will also short the acquiring company's shares .

Since this is a relatively new fundit started trading this past Decemberperformance data versus its peers is not available. However, the name recognition of its index provider could give this ETF the edge in gathering assets and tradability versus the other ETFs on this list. Expenses currently run 0.75%.

Disclosure: No positions at time of writing.

Related Articles
  1. Stock Analysis

    3 Resilient Oil Stocks for a Down Market

    Stuck on oil? Take a look at these six stocks—three that present risk vs. three that offer some resiliency.
  2. Economics

    Keep an Eye on These Emerging Economies

    Emerging markets have been hammered lately, but these three countries (and their large and young populations) are worth monitoring.
  3. Stock Analysis

    Is Pepsi (PEP) Still a Safe Bet?

    PepsiCo has long been known as one of the most resilient stocks throughout the broader market. Is this still the case today?
  4. Investing

    The ABCs of Bond ETF Distributions

    How do bond exchange traded fund (ETF) distributions work? It’s a question I get a lot. First, let’s explain what we mean by distributions.
  5. Investing Basics

    Top Tips for Diversifying with Exotic Currencies

    Is there an opportunity in exotic currencies right now, or are you safer sticking to the major ones?
  6. Mutual Funds & ETFs

    The 3 Biggest Mutual Fund Companies in the US

    Compare and contrast the rise of America's big three institutional asset managers: BlackRock Funds, The Vanguard Group and State Street Global Advisors.
  7. Stock Analysis

    3 Stocks that Are Top Bets for Retirement

    These three stocks are resilient, fundamentally sound and also pay generous dividends.
  8. Professionals

    5 Top-Rated Funds for Your Retirement Portfolio

    Mutual funds are a good choice for emotional investors. Here are five popular funds to consider.
  9. Investing News

    Are Stocks Cheap Now? Nope. And Here's Why

    Are stocks cheap right now? Be wary of those who are telling you what you want to hear. Here's why.
  10. Investing News

    4 Value Stocks Worth Your Immediate Attention

    Here are four stocks that offer good value and will likely outperform the majority of stocks throughout the broader market over the next several years.
  1. Can mutual funds invest in IPOs?

    Mutual funds can invest in initial public offerings (IPOS). However, most mutual funds have bylaws that prevent them from ... Read Full Answer >>
  2. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  3. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  4. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  5. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  6. What does a high turnover ratio signify for an investment fund?

    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 >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!