Shaking on a dealWith interest rates so low and corporations sitting on $2 trillion in cash, a slew of mergers and takeovers across a number of industries appears likely in 2011. That should give investors plenty of opportunity to capitalize on large corporations' willingness to pay premium prices to acquire competitors or strategic partners. Priivate equity firms and hedge funds will also be very active acquirers.

Most target companies' stock prices rise after a merger is announced, especially if a bidding war develops among several competing acquirers. So, investors who want to capitalize on M&A should begin developing a strategy now. But how?

One way to take advantage of next year's M&A revival would be for investors to identify takeover targets themselves, but that's extremely difficult. More feasible would be to scout out mutual funds or exchange traded funds (ETFs) that aim to profit from the M&A boom.

The Only M&A ETF

Experts say a strategy know as "merger arbitrage" can diversify an investment portfolio because it's generally less volatile than pure equity investments in potential merger companies, and it works in all market conditions. Mutual funds that pursue merger-arbitrage strategies include the Merger Fund (MERFX), the Arbitrage Fund (ARBFX) and the AQR Diversified Arbitrage Fund (ADAIX).

The IQ Merger Arbitrage ETF (MNA), which is a little more than a year old, is currently the only ETF that attempts to replicate the market for global mergers. Adam Patti, CEO of IndexIQ which manages the ETF, says his firm focuses on merger targets after they've been announced, then it uses special criteria to determine how they're likely to perform post-merger. Each month, IQ Merger Arbitrage evaluates the field and buys the best prospects to hold in its portfolio.

"The typical successful deal moves 3% to 4% higher over an average 120-day holding period," Patti says. Many mergers send the target company's shares even higher.

Banking and Health Care Should Be Hot

Several sectors have already been identified as ripe for M&A next year. Financial services is likely to see more deals in 2011, and financial services research firm Keefe, Bruyette & Woods (KBW) has even listed banks it believes will be takeover targets next year.

Raymond James banking analyst Anthony Polini recently told The Wall Street Journal that he expects hundreds of banking sector takeovers within the next five years, mostly due to tougher economic conditions and more stringent financial regulations. "A lot will be below the radar, but I think we could go from 8,000 banks to 6,000," he said.

The health care industry is also ripe for more takeovers. Tim Nelson, an analyst at FAF Advisors, told Reuters recently that companies like Medtronic (MDT), Johnson & Johnson (JNJ), Abbott Laboratories (ABT) and Pfizer (PFE) will likely turn to acquisitions to improve their lagging performance over the past several years.

"[The] big guys are looking anywhere they can to get reasonable growth that can move their needle. That's not easy," said Nelson. "I think you'll see them buying more earlier-stage technology [companies]."

"A Great Spot to Be In"

Patti is forecasting a big year for mergers in the natural resources and small-cap technology. In the natural resources area, mining companies will be particularly attractive due to the scarcity of many mined commodities and the increasing demand from emerging-market countries like China and India.

"Whether they are mining gold or other materials, exploring for oil reserves or even agri-business-type companies -- that's really a great spot to be in," Patti says.

He also sees small tech companies as prime merger targets because they're more likely to see lucrative buyouts as an alternative to risky and expensive IPOs. Patti also notes that these companies will become attractive to cash-laden tech giants because "sometimes it's easier and cheaper to buy [technology and market share] than build."

The IQ Merger Arbitrage ETF currently owns shares of DelMonte (DLM), Genzyme (GENZ), J. Crew Group (JCG), AirTran (AAI), McAfee (MFE) and CommScope (CTV). As of Dec. 22, its total return is down 1.37% year-to-date, according to data from Morningstar. As of Dec. 22, total returns year-to-date for the Merger Fund are up 2.96%, the Arbitrage Fund is up 1.58% and the AQR Diversified Arbitrage Fund is up 4.44%.

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26 Comments

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Larry

one wonders if the reporter, matthew scott, has an investment in any of the funds and companies he recommends.

December 27 2010 at 2:23 AM Report abuse rate up rate down Reply
Iselin007

And then there were riots

December 26 2010 at 11:51 PM Report abuse +2 rate up rate down Reply
1 reply to Iselin007's comment
icemanbill23

Oh, there will be riots all right, but not because of corporate mergers.
Necessary cuts in entitlements will outrage third generation welfare families and there will be blood.

December 27 2010 at 12:44 AM Report abuse rate up rate down Reply
Iselin007

Please sing my song from the halls of Congress to the factory floors everywhere in the USA

December 26 2010 at 11:26 PM Report abuse +1 rate up rate down Reply
Iselin007

Sing:
Save the jobs
Stop the mergers and beat them with clubs
Save the jobs
Sue the SOBs and the CEOs
Save the jobs
We don't need NAFTA or China
Save the jobs

December 26 2010 at 11:22 PM Report abuse +2 rate up rate down Reply
zjunk10

Wow these super hot merger funds are running a staggering 3% total return. The S&P 500 is running 14% for the year. Stodgy, nobody's interested regional telecoms 35%. If this guys so smart, why is he punching the paycheck clock? The only way you make out is to have the stock when it gets acquired & sell it. Unless you have inside information, it's just luck. After the deal, things always fall off for the merged company. The premium they pay for the acquisition eats years of earnings growth. And, cash is replaced by "goodwill", weakening the balance sheet too so it's generally lose-lose for at least 3-5 years.

December 26 2010 at 10:38 PM Report abuse +1 rate up rate down Reply
3 replies to zjunk10's comment
Robert & Lisa

They have even said they are out to take whatever wealth you have and redistribute it. They took the GM bond holders money and gave it to the unions. Go ahead, lose it all or put it into precious metals... The socialists are in power now and it is in doubt whether they will still be in power in two years. Our country is near it's fall, just like the Roman Empire...

December 26 2010 at 10:01 PM Report abuse -1 rate up rate down Reply
3 replies to Robert & Lisa's comment
rwdvddndcrw

Stay out of the kitchen if can't stand the heat, or if you can't cook! Same with the Market!

December 26 2010 at 9:30 PM Report abuse -1 rate up rate down Reply
Larry

Damn, what a buch of crybaby losers here.

December 26 2010 at 9:04 PM Report abuse rate up rate down Reply
1 reply to Larry's comment
icemanbill23

Yea, especially "gondanger1071"....he must have lost his ass on bad investments!..I can feel his pain.

December 27 2010 at 12:49 AM Report abuse rate up rate down Reply
BERNIE/LOIS

Remember the days when a black man had a Cadillac in his driveway.........now he's lucky if he has a garbage can there.

December 26 2010 at 7:41 PM Report abuse rate up rate down Reply
3 replies to BERNIE/LOIS's comment
gardeningatnite

Tell that Muslim clown that we don't need more government takeover mergers. Frnaka, Dodd and soroes must be impeached! The dumpbocrats are ruing the maekett!

December 26 2010 at 6:43 PM Report abuse +1 rate up rate down Reply
1 reply to gardeningatnite's comment
savemycountry911

I'm guessing you aren't the real garden. Either that or you got a clue.

December 26 2010 at 9:59 PM Report abuse rate up rate down Reply