Manager Research Newsletter: May 2017

A Low Cost, Low Vol Way to Take Advantage of Tax Reform

There is a trend in the equity market that has been on a fantastic run and is unlikely to slow down anytime soon. 2017 is on pace to be another record year with the wind at its back. Forces driving it even faster are corporate tax reform, lower for longer rates, and decreased regulations. We are speaking about mergers & acquisition (M&A) activity. It has been booming over the past few years, as companies have raced to become bigger and better; however, organic growth has been difficult to come by. 2015 has been cited as the biggest M&A year ever, with 2016 being the third-busiest on record. Looking at data since 2010, the first two months of 2017 have outpaced the same period in 2015 by over 50% in terms of announced deal value and over 25% in terms of deal count. (Source: FactSet, as of 2/28/17.)

Recent news certainly points to the likelihood of tax reform under a Republican majority. To the extent tax law changes leave more cash in the hands of U.S. companies, this could bolster acquisition activity. There has also been much discussion of how to bring the hundreds of billions of dollars held overseas by U.S. companies back to the United States, with the anticipation of a possible tax holiday allowing foreign earnings to be repatriated at a lower tax rate. This could lead to U.S. companies having more financial resources for acquisitions. In order to take advantage of the increased M&A activity, a merger arbitrage strategy should be considered, when suitable. Merger arbitrage is a popular hedge fund strategy that seeks to generate attractive risk-adjusted returns, with low correlation to the equity markets.

In the merger arbitrage space, the IQ Merger Arbitrage ETF (MNA) has outperformed its market neutral peer group by providing 182, 290, and 269 basis points of excess return over the 1-, 3-, and 5-year period as of March 31, 2017. The standard deviation for MNA has also been lower than its peers over the 1- and 3- year periods (3.48 vs. 4.48; 3.63 vs. 4.44) ended March 31, 2017. Even more striking is that it does it at a much lower fee and with much greater tax efficiency than its active management peers. In recognition of the ETF's accomplishments, the fund is rated five stars by Morningstar ( and was the only alternative ETF that received a positive mention on performance by Morningstar ( (Source: Morningstar, Peer Group: Market Neutral, as of 3/31/17.)

An Inexpensive, Tax-Efficient, and Competitive way to Invest in Merger Arbitrage

The IQ Merger Arbitrage ETF (MNA) is a mechanical merger arbitrage solution, based on extensive analysis across approximately 13,000 merger & acquisition transactions over 12-year period (1997 through 2009). It is a proprietary, rules-based approach to invest in global companies and unlike active managers who might speculate on potential takeover targets, MNA will only buy announced deals. Opportunities are identified globally across all market caps, industry sectors, and developed countries. The strategy differentiates itself by purchasing select target companies and selling short the sector (domestic) or region (international) of the acquirer and not the actual acquirer. This serves as a valuable hedge to market volatility.

Accessing M&A via an ETF is more cost-effective when compared to limited partnerships and mutual funds, due to the creation and redemption process of ETFs. In addition, M&A investing is typically a high turnover strategy that can be very tax-inefficient in a limited partnership or mutual fund structure, due to the significant pass-through of capital gains. MNA has only issued one capital gain in 2010.

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A Unique Hedge and Investment Process that Drives Performance and Protection

In a typical Merger Arb strategy, the arbitrageur buys the targeted company and sells short the acquiring company, based on the ratio of equity that may be used in the transaction. IndexIQ believes that by employing a sector or regional hedge, this exposure would act as an adequate proxy for the acquiring company's equity that would be sold short in a traditional arbitrage strategy. The hedge is based on the acquiring company and where it is domiciled. For domestic companies (U.S. or Canada), S&P 500 sector ETFs or an equivalent is used. For international and emerging companies, shorting specific stocks can be problematic; therefore, regional ETFs are used, and the regions are broken into Continental Europe and the UK, Asia Pacific ex-Japan, Japan, and emerging markets.

The primary risk within merger arbitrage is a deal break-up, due to factors like regulatory issues (i.e, anti-trust issues or The Committee on Foreign Investment in the United States (CFIUS) preventing foreign ownership of domestic companies), or the deal is terminated and withdrawn. Cancelled deals are not removed immediately, but instead at the monthly rebalance. This seeks to take advantage of any potential rebound that may occur after the initial selloff in the target company. To avoid holding on to deals too long, each deal is assigned a probability scenario with a prescribed maximum age limit. The majority of deals has a 180-day maximum age limit, with the very rare occasion of deals having an absolute 360 days maximum age limit. When a deal reaches its maximum age limit, it is removed from the index at the following rebalance. Based on our research, the longer a deal takes to complete, the higher the likelihood of the deal not being completed due to regulatory issues.

Deal or No Deal

Such protections in the construction process have helped to navigate the regulatory scrutiny that some deals have faced. An example on how this has helped to protect investors from a broken deal can be seen in the aforementioned Halliburton/Baker Hughes deal, which was announced in November 2014 and ultimately terminated in May 2016. Baker Hughes was added to the index in December 2014, but was taken out in August 2015 because of the 180-day maximum age limit. This strategy rule saved investors from a 16% loss in Baker Hughes from the time of its deletion from the MNA index to the termination of the deal.

Another example is the Staples/Office Depot deal, which was announced in February 2015 and terminated in May 2016. Office Depot was added to the index in March 2015, but was taken out in September of 2015 due to the 180-day maximum age limit. From the time Office Depot was taken out of the index to the termination of the deal, the stock fell 52%. There may have been instances where this process had a negative effect on the index.

A Valuable Hedge for Market Volatility

With the U.S. equity markets at or near their all-time highs, a merger arbitrage strategy may be a good way to provide downside protection. The Fund seeks to track, before fees and expenses, the performance of the IQ Merger Arbitrage Index. The goal is to provide more consistent returns, while serving as an important capital preservation tool that provides drawdown protection in times of market stress. MNA has proven to provide this as the sector and international developed hedges have mitigated large drawdowns.


When suitable, merger arbitrage may be a good way to take advantage of the increased activity in M&A activity in 2017. Added benefits are ways to diversify equity exposure, help manage equity volatility, and to mitigate downside risk. The IQ Merger Arbitrage ETF (MNA) has differentiated itself from its peer groups with the rules-based process that is followed. Furthermore, it is a more cost-efficient and tax-efficient way to access merger arbitrage.

For more information about IndexIQ’s IQ Merger Arbitrage ETF:

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Committee on Foreign Investment in the United States (CFIUS) is an inter-agency committee authorized to review transactions that could result in control of a U.S. business by a foreign person ("covered transactions"), in order to determine the effect of such transactions on the national security of the United States.

About Risk
Certain of the proposed takeover transactions in which the Fund invests may be renegotiated, terminated or involve a longer time frame than originally contemplated, which may negatively impact the Fund's returns. The Fund's investment strategy may result in high portfolio turnover, which, in turn, may result in increased transaction costs to the Fund and lower total returns. The Fund is susceptible to foreign securities risk - since the Fund invests in foreign markets, it will be subject to risk of loss not typically associated with domestic markets, including currency transaction risk. Diversification does not eliminate the risk of experiencing investment losses. Stock prices of mid and small capitalization companies generally are more volatile than those of larger companies and also more vulnerable than those of larger capitalization companies to adverse economic developments. The Fund is non-diversified and is susceptible to greater losses if a single portfolio investment declines than would a diversified fund. The ETF should be considered a speculative investment with a high degree of risk, does not represent a complete investment program and is not suitable for all investors.

Consider the Fund's investment objectives, risks, and charges and expenses carefully before investing. The prospectus and the statement of additional information include this and other relevant information about the Fund and are available by visiting or calling 888-934-0777. Read the prospectus carefully before investing.

MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. IndexIQ® is an indirect wholly owned subsidiary of New York Life Investment Management Holdings LLC. ALPS Distributors, Inc. (ALPS) is the principal underwriter of the ETFs. NYLIFE Distributors LLC is a distributor of the ETFs and the principal underwriter of IQ Hedge Multi-Strategy Plus Fund. NYLIFE Distributors LLC is located at 30 Hudson Street, Jersey City, NJ 07302. ALPS Distributors, Inc. is not affiliated with NYLIFE Distributors LLC. NYLIFE Distributors LLC is a Member FINRA/SIPC.