Investors looking to profit from them have a number of options, including mutual funds or ETFs that specialize in buying shares of companies are being acquired.
But don't expect to make a killing. These funds - and there are at least a half-dozen of them - are generally considered to be having a good year if they beat the meager returns of Treasury bills. While it may be hard to get excited about that kind of performance in a near-zero interest environment, it looks a lot better in a year when stocks are underwater as they are now.
Indeed, what investors in these funds are expecting are low risks from highly diverse portfolios so they are likely to have more money at the end of the year than at the beginning. The Touchstone Merger Arbitrage Fund (TMGAX) , the Gabelli ABC Fund (GABCX) - Get Report and the IQ Merger Arbitrage ETF (MNA) - Get Report have been among the best and most consistent performers.
All three have beaten the S&P 500 Index this year to date. While the stock index has lost 3%, Touchstone and Gabelli have registered gains of 1% and 2%, respectively. (IQ has been flat, though its long-term record has been better than the two mutual funds.)
Any gains come from buying shares in a company that is being acquired, but for less than the acquirer plans to pay, then cashing out when the deal is done. Because most mergers are completed, generally within a matter of months, it's a pretty safe bet that buyers will earn the difference, or spread, between the two prices.
The favorable odds go a long way toward explaining why merger or risk arbitrage, as the strategy is known, produces returns that tend to be lower on average than those of other stock investments.
Investors trying to buy the shares after a merger announcement can't expect to get the stock for much less than the acquirer's offer, because the current shareholders can reasonably count on getting that price shortly. How much less depends on a number of factors for both buyer and seller - for example, what their money could reliably earn in another investment, like three-month Treasury bills, or the value attached to the slight possibility that the deal will fall through (say, over regulatory problems).
Investors need to be concerned with costs. It's not unusual for their expense ratios to be above average. Gabelli's however, charges .61% or less than half the 1.25% mutual fund benchmark, but requires a minimum $10,000 investment. Touchstone's cost is 1.68%, with a $2,500 minimum, while IQ is .75% versus .44%, the average for ETFs.
There are also taxes to consider. Since these funds deal in short-term trades, they have to pay capital gains taxes on any money they make. The sting is likely to be less though, when the investments are part of retirement accounts.
An inexpensive alternative to the arbitrage funds is small-cap index funds. While a big beer merger grabs headlines, small-cap funds provide plenty of direct exposure to takeovers because many small companies are targets. These investments bring with them more risk, but greater upside potential. IShares S&P SmallCap 600 Index ETF (IJR) - Get Report is one small-cap index fund that has edged out the S&P Index this year.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.