These ETFs Are Awash in 2013 Takeover Targets

December 16, 2012

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One of the advantages of sector ETFs is that these funds allow investors to participate in some of the upside of mergers and acquisitions news without the burden of having to pick the shares of the exact that is being acquired.

Yes, it can be dangerous to own an individual stock with the intent of that company being acquired. The risk in that scenario is that the company is rumored to be a takeover, the shares run higher on the rumor and when a deal never transpires, the shares plunge.

ETFs help temper that risk for investors and offer another advantage: It is far easier to identify sectors with multiple takeover targets than it is to buy the single stock from that group that will be the next to draw a suitor’s affection. With that in mind, here are some ETFs whose holdings feature multiple, legitimate 2013 takeover targets.

First Trust NYSE Arca Biotechnology Index Fund (NYSE: FBT) The biotechnology sector has kept mergers and acquisitions teams at a various investment banks busy this year. More importantly, the sector has rewarded investors with stellar returns and the First Trust NYSE Arca Biotechnology Index Fund is just one of several biotech ETFs that have produced jaw-dropping returns this year.

In the wake of Amgen’s (NASDAQ: AMGN) most recent acquisition, biotech is once again be touted as fertile ground for takeover activity in 2013. This is why FBT makes for the better ETF play on that theme than rivals such as the iShares Nasdaq Biotechnology Index Fund (NASDAQ: IBB) or the SPDR S&P Biotechnology ETF (NYSE: XBI).

IBB allocates about 28 percent to biotech’s big four – Amgen, Celgene (NASDAQ: CELG), Biogen (NASDAQ: BIIB) and Gilead Sciences (NASDAQ: GILD). IBB’s weight to that quartet, who are buyers not sellers in biotech M&A, is more than 700 basis points higher than FBT’s allocation to the same group.

For its part, XBI is essentially an equal-weight ETF and that is a great thing when it comes to total returns. However, it diminishes the ETF’s utility as a biotech ETF play, unless there is a substantial amount of deal-making in the sector in a condensed period of time. With FBT, investors get an ETF that is up almost 43 percent in 2012 and one that is more heavily allocated to credible takeover targets.

First Trust ISE-Revere Natural Gas Index Fund (NYSE: FCG) It feels like it has been awhile since there has been some large-scale M&A activity in the U.S. energy patch to talk about. Recent headlines indicate that could change due to the strong balance sheets and faltering oil output at some of the major integrated companies.

Not only has Exxon Mobil (NYSE: XOM) been named as a possible acquirer, but rival Chevron (NYSE: CVX) has as well.

Those two companies are not members of FCG’s lineup, but the ETF is home to plenty of firms that Exxon and Chevron could afford to acquire. More importantly, FCG’s constituency is comprised of companies the likes of Exxon and Chevron may need to acquire.

Several of FCG’s 31 holdings have already been rumored to be take over targets, including Range Resources (NYSE: RRC), Anadarko Petroleum (NYSE: APC) and maybe even Devon Energy (NYSE: DVN). If any of this ETFs holdings do get bought out next year, it will likely be the ones with oilier profiles that go first.

PowerShares KBW Regional Banking Portfolio (NYSE: KBWR) Here is one clue that this unheralded ETF is awash in takeover targets: It is often that healthy banks with price-to-book ratios below two can be viewed as attractive acquisition candidates. KBWR is home to 50 stocks, almost all of which are small caps, with a weighted harmonic average price-to-book ratio of 1.15, according to PowerShares data.

Another factor to consider: Several of KBWR’s holdings are based in California or Texas, two of the most important banking markets in the U.S. They are also two of the most competitive. That makes it more tempting for banks that want to operate in those states to buy existing brands rather than trying to set up shop on their own.