Target the Red-Hot Spin-Off and Merger Space With These ETFs

Spin-offs and mergers may appeal to investors because they can signal a company's efforts to focus its business, realign its operations, or even seek new leadership. In the case of large conglomerates, it can be hard for investors to accurately assess which units might be the most profitable or fastest-growing—a spin-off can help clarify.

These deals can also lead to new opportunities to find high-growth businesses that were once attached to more stable firms, or to access mispriced stocks that have been impacted by forced selling by institutional investors or funds. However, because keeping track of all of the M&A and spin-off activity taking place across the market may take up a disproportionate amount of an investor's time, two exchange-traded funds (ETFs) are uniquely designed to focus on developments of this kind.

A High-Flying Spin-Off Fund Successfully Capturing Growth Opportunities

The Invesco S&P Spin-Off ETF (NYSEARCA: CSD) targets an index of firms that have recently gone through a split, leading to the dismantling of a portion of a business and its formation as a new publicly traded entity. Investors in this fund make a bet that the spin-off process may be able to open access to new value in this new company, allowing for outsized growth.

Specifically, CSD focuses only on the companies that have been spun off (and only those going through this process within the last four years), not the preexisting firms that did the spinning off. It also includes companies across the full market capitalization spectrum, given that many companies emerging from spin-offs are substantially smaller than their larger siblings. The majority of firms in CSD's basket are mid-cap companies, and it includes both highly publicized spin-offs like GE Vernova Inc. (NYSE: GEV) as well as more niche firms like Solventum Corp. (NYSE: SOLV), which spun off from 3M Co. (NYSE: MMM).

The universe of recent spin-offs is not huge, and CSD has just over two dozen holdings in its portfolio. These are not weighted evenly, and the largest position represents more than 12% of the total asset base. The combination of fairly narrow basket and selected companies being heavily weighted means that CSD may carry greater risks than some other broader funds. However, its year-to-date (YTD) return of more than 35% might go a long way to ease investor concern, even with an expense ratio of 0.64%.

A Merger Arbitrage Approach Condensed Into an ETF

On the other side is the ProShares Merger ETF (BATS: MRGR), an ETF with a merger arbitrage strategy, capitalizing on the spread between the current stock price of a potential acquisition target and the price offered by the acquiring company. Because merger arbitrage can be a complex and risky endeavor for investors to take on independently, a passively managed ETF may make for an easier access point.

MRGR targets roughly 40 companies and divides its investments fairly evenly across its portfolio. As an arbitrage-focused fund, MRGR employs both long and short positions to profit from price inefficiencies. On the long side it is most heavily weighted toward health care and financials names, while on the short side it focuses primarily on materials and industrials.

Thanks to its unique approach, MRGR is not designed to move in tandem with the share prices of its holdings over time. The fund has so far returned only about 1% YTD, but it pays a compelling distribution. Investors currently enjoy a dividend yield of about 3.2% from this fund. For its uncommon strategy, investors should expect to spend a bit more for this fund—its expense ratio is 0.75%.

Of course, there are other ways mergers can be profitable as well, but investors may have to seek companies looking to merge outside the ETF space. Still, a relatively modest level of risk in the form of an arbitrage-focused ETF may appeal to investors seeking an alternative approach to companies in this stage of development.

Investors might want to keep in mind that the two funds above may perform very differently depending on overall market conditions. Spin-offs, for example, tend to do well during bull markets when investors have more of an appetite for riskier high-growth names. Merger arbitrage is a useful approach during volatile periods because it doesn't rely on market direction. In this way, the funds may balance one another out and provide opportunities to benefit in contrasting environments.

Where Should You Invest $1,000 Right Now?

Before you make your next trade, you'll want to hear this.

MarketBeat keeps track of Wall Street's top-rated and best performing research analysts and the stocks they recommend to their clients on a daily basis.

Our team has identified the five stocks that top analysts are quietly whispering to their clients to buy now before the broader market catches on... and none of the big name stocks were on the list.

They believe these five stocks are the five best companies for investors to buy now...

See The Five Stocks Here

The article "Target the Red-Hot Spin-Off and Merger Space With These ETFs" first appeared on MarketBeat.