Jeff Benjamin

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Jeff Benjamin breaks down the game for advisers and clients.

Time to jump on the M&A bandwagon

Think in terms of diversification, not outperformance

Apr 17, 2014 @ 1:16 pm

By Jeff Benjamin

M&A, mergers and acquisitions, mutual funds, diversification, etfs
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This week's announced $6.25 billion acquisition of Nuveen Investments Inc. by TIAA-CREF stands out as the latest evidence that the math continues to make sense for consolidation, and that M&A is alive and well.

And the good news is, it's not too late to gain some exposure to the deal activity in a way that could also introduce some crucial portfolio diversification.

“These kinds of announced deals are examples of two dynamics converging in the market and driving deal flow,” said Matt Porzio, vice president of strategy and product marketing at Intralinks Holdings Inc., which monitors due diligence research to help forecast future merger and acquisition activity.

“First, we're talking about the need in financial services to buy growth and compete with larger and more diversified assets, and second, the necessary shedding of sideways [leveraged buyouts] in seven-to-10-year-old vintage private equity funds,” he added. “Globally, financial services was a significant portion of deals reaching due diligence over the last 12 months, and [our research] shows the trend of robust M&A activity continuing with a 30%-plus increase in deals in this sector from the last quarter.”

According to the most recent report from the Intralinks Deal Flow Indicator, based on data compiled through the end of March, the next six months should see a 16% increase in year-over-year global M&A activity. The quarterly analysis is based on information that Intralinks gleans from its virtual data rooms that enable potential buyers and sellers to conduct discrete market due diligence.

The report also includes the results of a sentiment survey of 1,000 global M&A professionals.

Overall, 73% of respondents expect M&A activity to increase over the next six months.

For financial advisers and investors, this kind of information should translate to an ideal time to diversify into established and better-known mutual funds and exchange-traded funds that offer access to the deal space.

(See also: Independent B-Ds eager to see more M&A activity )

While packaged M&A products will come in multiple flavors, the general idea usually involves some variation on going long the target company and going short the acquiring company. That's where the hedging component comes in, because it is essentially a market-neutral strategy.

Keep in mind that even though we're talking about jumping on the bandwagon of a running trend, this is still less about enhanced performance and more about diversification.

Even though the M&A space has been gaining steam for a few years, the performance of some of the leading funds in the category has been less-than stellar, as financial adviser Thomas Meyer is quick to point out.

“With all the M&A activity since 2009, I thought that would give us some alpha, but you could almost use it as a cash component,” said the chief executive of Meyer Capital Group.

“That might change a year from now, but right now those funds are deader than a doornail,” he added. “I put them in the category of managed futures funds; they helped in 2008, but ever since they haven't been worth the expense.”

Based purely on recent performance, when compared to a powerful and seemingly resilient equity market run, it is easy to criticize the missing alpha component in the M&A fund space. But, again, it's important to think in terms of diversification, particularly as markets get choppier.

The $5.3 billion Merger Fund (MERFX), which is by far the largest fund in the M&A space, has gained less than 1% since the start of the year, which compares to a much more volatile 1.4% advance by the S&P 500 Index.

The Merger Fund, managed by Michael Shannon at Westchester Capital Funds, gained 3.6% during each of the last two years, a far cry from the S&P 500's 16% in 2012 and 32% last year.

But dial the clock back to 2008 when all hell was breaking loose across the financial landscape and the S&P dropped 37% while the Merger Fund lost only 2.3%.

The story is similar for the $2.6 billion Arbitrage Fund (ARBFX), managed by Todd Munn at The Arbitrage Funds.

The fund is essentially flat this year, and has gained less than a percentage in each of the past two years, but when defense mattered more than anything in 2008, the fund was down less than 1%.

Both of these M&A funds have four-star ratings from Morningstar Inc., and have below-average expense ratios, and have performed in line with the average market-neutral fund, along with which they are categorized.

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