Water Island debuts AltShares brand with global merger arbitrage ETF

May 14th, 2020 | By | Category: Alternatives / Multi-Asset

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New York-based Water Island Capital has become the latest entrant to the ETF industry with the launch of the AltShares Merger Arbitrage ETF (ARB US) on NYSE Arca.

John S. Orrico, Founder and CIO of Water Island Capital.

John S. Orrico, Founder and CIO of Water Island Capital.

The fund harnesses the firm’s 20-years of experience in managing event-driven portfolios to provide passively managed exposure to a global merger arbitrage investment strategy.

Merger arbitrage aims to capture the ‘deal spread’ of a potential acquisition by taking a long position in the target company and a short position in the acquirer.

A merger arbitrageur looks at the risk the merger deal will not close on time, or at all. Because of this slight uncertainty, the target company’s stock typically sells at a discount to the price of the combined company when the merger is closed. This difference represents the profit to the manager of a merger arbitrage hedge fund strategy.

The ETF’s underlying index is the Water Island Merger Arbitrage USD Hedged Index which seeks out definitive, publicly announced mergers, acquisitions, tender offers, leveraged buyouts, and private equity takeovers across developed markets globally. Eligible transactions must have a deal size in excess of $200m.

Rumours, proposals, hostile bids, minority divestitures, unit divestitures, and minority interests will not be included.

The index is composed of long positions in all target companies and short positions in acquirer companies for transactions which include a stock payment to target shareholders. Certain deals will be excluded if they fail to meet Water Island’s proprietary risk tests.

In determining the weights of the long positions, the target companies are ranked by 30-day average daily trading volume and divided into quintiles. The weights of the quintiles from top to bottom are as follows: 33.3%; 26.7%; 20%; 13.3%; 6.7%. Within each quintile, target companies are equally weighted.

The weights of the short positions are determined by the relevant transaction’s stock ratio (how many shares an acquiring company needs to issue for each share in a target company to provide the same relative value).

The index is reconstituted and rebalanced twice per month.

John S. Orrico, Founder and CIO of Water Island Capital, commented, “We are pleased to bring Water Island’s time-tested approach to merger arbitrage investing to those interested in accessing this strategy through a passively managed ETF. We have leveraged the insights we derived over the course of our firm’s 20-year history to build a passive ETF for investors looking to merger arbitrage investing as a way to enhance portfolio diversification.”

The ETF comes with an expense ratio of 0.75%, slightly cheaper than the largest existing merger arbitrage ETF, the $720m IQ Merger Arbitrage ETF (MNA US), which costs 0.78%.

MNA is offered by fellow New York alternative investment specialist IndexIQ and is linked to the IQ Merger Arbitrage Index which consists of developed market stocks for which there has been a public announcement of a takeover by an acquirer. IndexIQ calculates probability scenarios for each eligible deal, removing stocks for which it concludes the probability of a profitable return too low. The remaining constituents are then weighted by their seven-day median trading value.

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