How Corporate Action ETFs Work

Corporations are making moves. Initial public offerings (IPOs), mergers, acquisitions and other corporate actions have picked up pace in September after the coronavirus pandemic slowed things down at the start of the year.

This month, chipmaker Nvidia purchased Arm Limited in the biggest semiconductor deal ever, while cloud database warehouse company Snowflake raised more than $3 billion and then proceeded to double in its first day of trading—the biggest pop for a billion-dollar IPO in 20 years, according to Renaissance Capital.

Let’s not forget the sudden resurgence of the share split, which was left for dead in recent years. Apple and Tesla split their shares recently, spurring a wave of interest in those stocks from retail investors.

Certain corporate actions, like share splits, are merely cosmetic. But others, like mergers and acquisitions, can be a much bigger deal for investors.

A number of ETFs have arisen to take advantage of these corporate moves, but their strategies and returns can vary significantly. Here we’ll take a look at some of them.

IPO Market Sizzling

The IPO is one of the most exciting times for companies. It’s a chance for a promising business to introduce itself to and raise money from the wider investment community for the first time.

With tech stocks on a tear, investors have been especially keen to buy into all of the hot new tech IPOs, many of which have soared 50%, 100% or more on their first day of trading. According to Renaissance Capital, the amount of money raised in IPOs this year is the greatest since 2014.

The performance has been stellar, too. While most investors can’t buy into an IPO at the price set by the company and its investment banks—that’s usually reserved for large institutions—they can buy them on the open market once trading begins. Even after accounting for that, IPOs have delivered hefty returns in 2020.

The First Trust U.S. Equity Opportunities ETF (FPX) and the Renaissance IPO ETF (IPO), two funds focused on new IPOs, are up 15.8% and 60.8%, respectively, on a year-to-date basis.

YTD Returns For FPX, IPO, S&P 500

FPX holds a basket of the 100 largest IPOs, with an aim to keep them in its portfolio for their first 1,000 trading days, or about four years. The smaller fund, “IPO,” keeps its holdings for two years.

Another difference between the funds is that if a stock is acquired or merges with another, FPX will hold the stock of the acquirer or merged entity, something rival “IPO” won’t do. That’s resulted in some unusual names ending up in FPX’s portfolio, such as Eli Lilly, Dow, General Mills and Kroger, among others—stocks of mature companies that have been around for ages and could hardly be considered fresh IPOs.

(Use our stock finder tool to find an ETF’s allocation to a certain stock.)

Over the past five years, the more focused “IPO” has outperformed, gaining 147.5% compared with 89.2% for FPX and 89% for the S&P 500.

Merger Arbitrage

Speaking of mergers and acquisitions, there are a few ETFs focused on M&A. Specifically, these funds employ merger arbitrage strategies; that is, they buy stocks of acquired companies (which initially trade at a discount to the takeover price), hoping to capture a tidy return when the acquisition officially closes.

The nearly $700 million IQ Merger Arbitrage ETF (MNA) is the biggest name in this space. It holds acquired company shares, partially offset by a short position in global equities broadly.

This long/short strategy is designed to capture returns with lower volatility than a long-only fund. In that regard, it has succeeded, but it will more often than not underperform long-only broad market equity ETFs when stocks are rising.

MNA was last trading with a 1.8% year-to-date loss, while the S&P 500 was up 4.2%. Over the past five years, MNA is up 16.9% versus 89% for the broader index.

YTD Returns For MNA, S&P 500

Spinoff Flop

If M&A is a way for a company to bulk up, a spinoff is the opposite. That’s when a corporation will spin one of its businesses into a separate company, leaving investors with stakes in two separate entities.

The Invesco S&P Spin-Off ETF (CSD), with $63 million in assets, is the sole spinoff ETF on the market.

The thesis behind this ETF is that a spun-off company is likely to create value by becoming more focused on its core business following the split from its parent.

Within a conglomerate, the individual business was just one of many, but following the spinoff, it is the focus―at least that's the theory. Unfortunately, that theory hasn’t translated into reality. CSD is down 12.5% this year, underperforming the S&P 500 significantly. Over the past five years, the fund is up 17.9%, much less than the 89% gain for the S&P 500 in the same period.

YTD Returns For CSD, S&P 500

 Email Sumit Roy at [email protected] or follow him on Twitter @sumitroy2