The merger funds are willing to buy when the shares are trading close to the acquisition price. Portfolio managers hold for periods ranging from one to four months. If they can earn 50 cents a share during a short holding period, then the funds will achieve a sound annualized return.
Fund portfolio managers aim to avoid deals that could collapse. Barbara McKenna, portfolio manager of Touchstone Merger Arbitrage (TMGAX), looks for mergers where the acquirer has much to gain from a purchase. She is wary of heavily leveraged buyouts that could collapse if financing proves to be shaky. Last year she profited when car rental giant Hertz Global Holdings (HTZ - Get Report) offered to buy Dollar Thrifty Automotive. McKenna bought the acquisition target's shares when they seemed likely to deliver an annualized gain of 5.5%.
ETF investors can try ProShares Merger (MRGR), which tracks the S&P Merger Arbitrage Index. The index includes shares of up to 40 companies that are the targets of publicly announced acquisition bids. The index excludes small companies and deals where acquirers seek to buy less than 50% of companies.
The ETF starts by putting 3% of its assets in each new deal. When there are not enough deals available, the ProShares fund holds cash. The cash stake could help to cushion the portfolio during bear markets when stocks are sinking and deals could collapse. Current holdings include American Greetings (AM - Get Report), Coventry Health Care (CVH), and OfficeMax (OMX).Follow @StanLuxenberg This article was written by an independent contributor, separate from TheStreet's regular news coverage.