IndexIQ’s chief of investments discusses his firm’s hedge funds and merger-arbitrage ETFs.
“Structure Matters,” by Dan Weiskopf, portfolio manager of Access ETF Solutions, examines issues about ETF structures in a series of interviews with ETF portfolio managers, index developers and other people who affect the structure of ETFs. The goal of the series is to highlight the different operating roles that individuals have that make the ETF structure work well for the investor.
In this interview, Weiskopf interviews Salvatore Bruno, chief investment officer of IndexIQ and the key person who developed the firm’s investment methodologies for their alternative hedge fund ETFs. Today IndexIQ is a leader in the ETF alternatives space, with about $1.3 billion in assets under management across 11 ETFs, its mutual fund and its separate accounts.
Dan Weiskopf: When somebody's looking at the IQ Hedge Multi-Strategy Tracker (QAI | C-70) or one of your funds, how should they be comparing them to hedge funds on an after-tax basis?
Salvatore Bruno: Generally those are very difficult to find. Most of the time it's on a gross-tax basis and not on a net basis. I've seen different academic studies that try to estimate the impact of taxes on hedge funds, and none of them are perfect. I've seen estimates anywhere from 200-400 basis points per annum of a tax drag on active hedge funds. Hedge funds also have K1s.
Weiskopf: Your merger strategy IQ Merger Arbitrage (MNA | D-95) did well last year. How's the strategy implemented? Does the investor lose out after a deal is announced?
Bruno: No. We've done a lot of research and will be releasing our second white paper soon on this issue. We found a nice academic paper by Mark Mitchell and Todd Pulvino that was written in the early 2000s which documented that the remaining premium on merger-arbitrage deals could still be captured after the fact, and that it was a profitable strategy, even after accounting for transaction costs.
To prove the concept, we then ran a bunch of backtests which today help us define risk. We have been very pleased by the live results from MNA since its inception November 2009.
MNA is different than QAI, which is an asset allocation or beta-hedge fund play. Merger arbitrage is really a mechanical implementation of a hedge fund strategy. So what we mean by that is we have a rules-based process to actually create a strategy that behaves just like a hedge fund would. We actually go into individual deals after they're announced and buy them into the index, and ultimately into the portfolio.
What we found is that there's still remaining premium if you wait until after the deal has been announced. If you wait until the beginning of the month after the announcement, still much of the premium remains. With a very high completion rate that we've seen historically, that gives you the opportunity to capture some of that premium in the form of performance in the fund.
Weiskopf: MNA now is allocated roughly 28 percent in small-caps, 25 percent large-caps and 22 percent midcaps. Is that a function of what deal flows are out there?
Bruno: We don't look in any particular deal size. We are concerned more with the liquidity of the deal than we are with the size of the company that's going in. It can also be because there is more volume trading in small-caps these days or because there is a bias of more names in the small-cap space being acquired.