Some high-profile buyout deals have been falling apart
For instance, the third largest U.S. wireless carrier
just announced it would end its bid to acquire rival
, the number four carrier, because of staunch resistance from
regulators. Media giant
21st Century Fox (NYSE:
ceased its pursuit of
Time Warner Cable (NYSE:
because the two simply couldn't agree on a buyout price. A recent
takeover attempt involving the big pharmaceutical firms
also went nowhere after the latter backed out at the last
These and other big deals gone sour have been getting plenty
of media attention, possibly giving the impression that M&A
activity is weakening. But that couldn't be further from the
According to software firm Dealogic, which offers multiple
services including M&A analytics, failure rates for M&A
deals have been falling since last year and are near
pre-recession levels. What's more, global M&A volume has
reached nearly $2.3 trillion this year, a 43% year-over-year
increase and the second-highest yearly total ever (after $3.1
trillion in 2007).
And it looks like there's plenty more to come.
In a second-quarter letter to shareholders, legendary investor
Jeremy Grantham predicted the greatest M&A boom ever. "I
think it is likely (better than 50/50) that all previous deal
records will be broken in the next year or two," he wrote. "If I
were a potential deal maker, I would be licking my lips at an
economy that seems to have enough slack to keep going for a few
Those are statements to heed given the reputation of Grantham,
chief investment strategist at GMO, the Boston-based asset
management firm he co-founded in 1977. Since then, he has earned
a spot among investing's all-time greats with, among other
things, an uncanny ability to spot asset bubbles. He's called all
the major ones of our time, including the Japanese stock bubble
of the late 1980s, the dot-com bubble of the late 1990s and the
2008 housing bubble.
So what's that connection between M&A and asset bubbles?
Well, in this case, Grantham expects the former will lead up to
the latter, although, as his comments suggest, this could take up
to a few years.
In the meantime, there are catalysts galore for an M&A
boom of historic proportions, and Grantham cites about half a
dozen: low interest rates, relatively high profit margins, the
economy being in a relatively early-stage recovery, massive labor
reserves and plenty of room for growth in capital spending.
Other analysts also pointed out that, because of high stock
prices, it's often cheaper for companies to make acquisitions
than buy back stock. Plus, many companies have accumulated
immense cash hoards and, with the economy seemingly on the mend,
are becoming more likely to take some risks with their cash
rather than just sitting on it.
Thus, it seems there's a clear opportunity for investors to
profit from dealmaking during the next couple years or so. The
question is how best to do it.
Since it's virtually impossible for individual investors to
keep up with all the M&A activity going on and be able to
separate fact from rumor, they're better off leaving the task to
mutual funds and/or exchange-traded funds (ETFs) designed to
capitalize on such activity. There are a couple options worth
A top choice -- and one that happens to have outperformed 95%
of its peers during the past decade -- is a mutual fund called
Merger Investor (
. Like most funds focused on M&A, MERFX uses a
merger-arbitrage strategy in which it buys the stocks of takeover
targets and shorts the stocks of the companies doing the buyouts.
This is because the stock of a company being acquired usually
goes up, whereas the acquiring firm typically sees its stock
MERFX usually allocates at least 80% of fund assets to M&A
(but will try to capitalize on reorganizations and bankruptcies
to some extent, too). According to Morningstar, the fund devotes
a big chunk of its research budget to law firms and other outside
experts to learn as much as possible about potential deals and
their chances of actually being inked.
Investors who prefer ETFs should consider the
IQ Merger Arbitrage ETF (NYSE:
, which tracks an index of companies that have announced they're
being acquired. But rather than shorting the stocks of the
acquiring firms, the fund simply shorts broad domestic and
international stock indexes (the S&P 500 and MSCI EAFE) as a
partial equity hedge.
Not pairing up long and short positions like MERFX hasn't
affected long-term performance, though. The fund's three-year
record is actually slightly better than MERFX's.
There's also the
Credit Suisse Merger Arbitrage Liquid ETN (NYSE:
, an exchange-traded note that, like MERFX, is long buyout
targets and short the acquiring firms. However, results indicate
the fund hasn't employed merger-arbitrage nearly as effectively.
Indeed, none of the investments I've described have has posted
exciting returns lately, but that could change dramatically if
M&A picks up like Grantham predicts.
M&A Fund Performance
|Merger Investor (
|IQ Merger Arbitrage ETF (
|CS Merger Arbitrage Liquid
Risks to Consider:
Considering the long-term performance of
merger-arbitrage-focused investments, it's possible their
strategy may not be capable of market-beating returns. Also,
Grantham sees M&A eventually pushing the stock market up to
"true bubble levels."
Action to Take -->
If you're intrigued by Grantham's assessment of M&A activity,
consider targeting the potential boom with one or more of the
investments I've described. Splitting your M&A allocation
equally between MERFX and MNA might be the best option, since
they're both solid performers and you'd get equal amounts of
actively managed and passive index approaches. Or, if Grantham is
right about the run-up to a bubble, simply tracking the market
may prove an even better way to reap the rewards of the M&A
surge -- if you manage to get out before the big pop.
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