Are Mergers & Acquisitions Back?

Uncertainty is tough on markets, and we have had lots of that. A global pandemic, social unrest, and now, we’re less 100 days from the presidential election.

But stocks have been rallying, and companies are again showing an interest in mergers & acquisitions as evidenced by recently announced deals, including Chevron’s $5 billion deal to acquire Noble Energy and eBay’s $9.2 billion sale of its classifieds unit. The oil patch in particular seems set for significant consolidation as declining crude prices have left some companies overextended and vulnerable to takeover.

The potential acceleration in deal making could be a positive for merger arbitrage. The goal in this strategy is to take advantage of the inefficiencies that can occur when a deal target trades at a discount to the announced acquisition price, with this “spread” expected to tighten as the deal moves towards the closing date. Merger arbitrage is designed to capture this price difference while adding diversification to a portfolio.

The IQ Merger Arbitrage Index ETF (MNA) was the first and is still the biggest ETF employing this strategy. Newly announced deals keep the pipeline flowing, with those that meet the investment criteria as defined in the fund’s prospectus added to the underlying index. A rising market has tended to be positively correlated with M&A activity. Given the pricing dislocations resulting from the pandemic, we would expect to see more deals announced over the course of the year as acquirers go bargain shopping.

For fund investors, the primary factors that have driven performance remain the same: deal premiums and completion rates, both of which tend to be fairly consistent over time. This positions the fund to potentially deliver two of the key benefits of a merger arbitrage strategy: a low correlation to both stocks and bonds, and relatively stable returns across various market environments.

But deal flow is important, and it tends to follow the performance of the S&P 500 Index, so a rising market has generally meant more transactions. Now, as before, there are the usual factors driving consolidation, strategic and financial. But there may be something more impacting the market in the midst of the ongoing pandemic and the subsequent economic shocks. In any severe market dislocation like we’ve recently experienced, there will be winners and losers. Some companies – and their share prices – will recover faster than others. Others will see opportunity – the ability to acquire a competitor, a new technology, or to expand into a new market. An appreciating stock can supply the currency to see these transactions through.

While it’s too soon to draw any sweeping conclusions, it looks like the drought in M&A transactions brought on by the pandemic may be coming to an end, and that may be a good sign for investors in merger arbitrage strategies.

Related: Looking Forward to Volatility, Vaccines, & Voting