CSMA: Can Merger Arbitrage Be Indexed?

Credit Suisse Merger Arbitrage Liquid Index ETN (CSMA) began trading October 4, 2010.  These ETNs are senior unsecured debt designed to provide investors with the returns of the Credit Suisse Merger Arbitrage Liquid Index.  The index attempts to capture the spread between the target company's price after an announced acquisition and the acquiring company's proposed price for the target.

For stock based acquisitions, the index strategy will typically purchase the target company and short-sell an equivalent value of the acquiring company.  For cash acquisitions, the strategy can be implemented by simply buying the stock of the target company.  CSMA has an annual investor fee of 0.55%.  The overview page includes tabs for current index components and links to the fact sheet and prospectus.

Instead of using monthly or quarterly rebalancing, the underlying index is rebalanced five days after the announcement of a new deal meeting various arbitrage constraints for inclusion in the index.  Likewise, busted deals in the index are converted to cash five days after such announcement, but the index is not rebalanced at that time.  When rebalancing does occur, positions are weighted by a special “size of the deal” calculation and capped at 7.5% net weight.

Credit Suisse conducted a 10-year backtest before making the index live on 12/31/2009.  After eight months of live performance, the index rules were revised on 9/1/2010.  All of the hypothetical performance information (going back to 2000) is based on the prior rules and therefore completely meaningless.  You can rightly assume the published backtest results look good.  After all, I'm not aware of any firm that launched a product based on a poor looking backtest.

Therefore, the answer to my “Can Merger Arbitrage Be Indexed?” question posed in the title of this article is a qualified yes.  Because the index rebalancing dates for CSMA are event-driven, and not calendar-driven, the index has the potential to capture the strategy.  Even so, I am of the belief that a certain amount of “art”, or subjective active-management if you will, is required for a merger arbitrage strategy to be successful over the long haul.  For now, I will continue to rely on the Merger Fund (MERFX) for my merger arbitrage exposure.

IQ ARB Merger Arbitrage ETF (MNA) was launched last November becoming the first ETP in this space.  However, its volatility has been ~400% greater than Merger Fund (MERFX) and Arbitrage Fund (ARBFX), the two actively-managed mutual funds that have been pursuing this strategy for years.

Disclosure covering writer, editor, and publisher:  Long MERFX.  No positions in any of the companies or ETF sponsors mentioned.  No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.