NEW YORK (TheStreet) --
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
. 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
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
More interesting is that the world knows
Potash Corp of Saskatchewan
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
, a publicly traded construction company.
Subject to liquidity screens, the fund will take long positions in companies where the takeover offer is cash, but in those deals there will be no corresponding short position.
Per a conference call held by Credit Suisse, there is no limit to the percentage of cash deals that the fund can hold, which means it could be totally unhedged which changes the dynamic of the fund.
While this scenario could change the volatility characteristics of the fund, knowledge of the holding is easily obtained on a daily basis at the Credit Suisse Web site. The fund could be sold if there is not enough hedged exposure to an investor's liking.
Anyone interested in the underlying strategy should also consider other merger arbitrage funds that exist which include traditional mutual funds such as the
and a recently listed ETF, the
IndexIQ Merger Arbitrage ETF
The two mutual funds have been around for years, operate under the hood very similarly to the Credit Suisse index and have long-term track records of outstanding risk-adjusted returns consistent with the back test of the new Credit Suisse ETN.
The Index IQ ETF has only been trading since last fall, has delivered a result consistent with the other funds but it does not sell short acquiring companies; it believes it can capture the effect by selling short broad indices. This difference has not mattered thus far but might under adverse market conditions.
Given that the merger arbitrage strategy has done well for so long, some exposure is justified for investors seeking to add risk-adjusted diversification to their portfolios.
However, about the only advantage I can see with the ETN structure, and the implication of buying debt from a bank, is that there is no tax consequence . There are no taxable distributions, until the fund is sold and of course, this is irrelevant for IRA accounts.
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At the time of publication, Nusbaum did not hold positions in any of the funds mentioned.
Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback;
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