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3 Ways to Make Money From M&A Rebound

Stocks in this article: MORN TRI MERFX FDO CEPH AAPL GOOG

BOSTON ( TheStreet) -- Mergers and acquisitions have died down in recent weeks.

Corporate executives have been selling, instead of buying, their companies' shares, and have held back on making bids for takeovers. The backdrop is a weak economy that may lower equity prices, making acquisitions cheaper. Deal announcements in the second quarter, at about $631 billion, fell 20% from the first quarter, according to Thomson Reuters.

Still, that's a backward-looking figure, and executives may be warming to buyouts as a debt ceiling mini-deal is rumored to be imminent and acceleration in growth is expected for the second half of the year.

One way to profit from deal activity, regardless of the market environment, is through merger-arbitrage mutual fund Merger (MERFX). Merger arbitrage, an investment strategy employed by specialized hedge funds, entails buying a stock below its targeted buyout price and then capturing the upside spread if the buyout closes. This little-known strategy has value.

Two other strategies, aside from the fund, are buying the individual securities of potential target companies or the stocks in hot sectors, especially technology.

As for the Merger fund, run by Westchester Capital Management, it receives a four-star rating from Morningstar (MORN). Over a three-year span, it has a superlative five-star rating. The fund hasn't delivered massive gains, but it has delivered alpha, or positive risk-adjusted return, over one, three, five and 10 years. Thus, investors looking for outperformance in a challenging economic environment may fare comparatively well in this fund. It has attracted about $4 billion of capital, but it has a lofty expense ratio, at about 1.4%.

That fee is sizable for a traditional mutual fund, but reasonable for a specialty fund like Merger. The fund uses advanced hedging techniques, including currency forwards, to negate risk from foreign buyouts and index options to hedge equity-market risk. Also, in addition to purchasing the stock of buyout targets, it also shorts the stock of the acquirer. It is one of the only mutual funds employing this strategy, which has counter-cyclical appeal, because it is, to an extent, market neutral. However, a weak equity market often correlates to tepid M&A.

Another way to play a second-half rebound in M&A is by purchasing targets that still offer decent upside to takeout offers. Five U.S. stocks that still offer sizable spreads and the possibility for arbitrage are Family Dollar Stores (FDO), Exco Resources (XCO), Constellation Energy (CEG), NYSE Euronext (NYX) and Cephalon (CEPH). However, the risk in these stocks is that regulators or shareholders disapprove of deald.

Another way to play a rebound in M&A is to invest in the sector with hot activity.

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