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ETN Banks on Merger Arbitrage Strategy

Stocks in this article: CSMACTLMERFXARBFXMNA

NEW YORK (TheStreet) -- Credit Suisse (CS) has been slowly wading into the exchange traded product market with ETNs that target some very narrow investment strategies.

The latest fund is the Credit Suisse Merger Arbitrage Liquid Index ETN (CSMA). As an exchange traded note, the fund will track an index with virtually the exact same name as the fund but does not own the stocks in the index. The actual ETN is simply an unsecured debt obligation of Credit Suisse.

The general strategy is to go long companies that have been announced as having received a takeover offer and selling short the acquirer with the aim of capitalizing on a widening spread between the two.

Merger arbitrage usually is done with the goal of an absolute return or as close to it as possible, with lower volatility than the broad market. Credit Suisse has plenty of data on the index to give an idea of how the strategy has performed.

We know that the S&P 500 peaked in October, 2007 and the Merger Arbitrage Liquid Index peaked in August, 2008. Over the course of the next month, the Merger Arbitrage Liquid Index dropped 16% to 17% in the middle of short-sale bans, massive financial company failures and a general seizing up of capital markets.

All in all, that is pretty good in the face of a breakdown in normal market functions. Th index has achieved a new high vs. the October 2007 peak while the S&P 500 is still down 25% from its peak.

In essence, the index is structured so that that the bigger the deal, the bigger the weighting in the fund. For now, the one largest potential deal in the index is CenturyLink's (CTL) purchase of Qwest Communications (Q).

More interesting is that the world knows Potash Corp of Saskatchewan (POT) is in play but there does not appear to be a corresponding short position.

The 7% weight in Potash is unhedged because as of now it would be a cash deal. This creates the opportunity for more volatility than normal because it is likely that the index will keep the Potash position until it is resolved one way or the other.

If there isn's a deal, it's possible Potash's stock could drop back to where it was before the initial offer, taking as much as a couple of hundred basis points out of the entire fund.

Also unhedged is the 2% weight to Societe Des Autoroutes Paris-Rhin-Rhone, the French toll road company that is being sought after by Eiffage (EFGSY), a publicly traded construction company.

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