There have been upwards of $1.6 trillion in takeover deals so far this year, $562 billion in the third quarter alone the busiest pace in two years, according to Bloomberg. And the deals keep coming. Just this week, Northeast Utilities announced plans to buy competitor NSTAR in a $4.2 billion agreement affecting nearly half of New England.

With merger announcements comes the return of merger arbitrage, a historically market-neutral strategy that involves buying the shares of the company being acquired and selling short those of the acquirer. Profits come as the price difference or spread between the two companies shares narrows and mergers are completed. Investors risk deals falling through, resulting in a loss, but over the past five years, a Credit Suisse merger index has delivered lower volatility and higher risk-adjusted returns than the S&P 500.

Like selling option premium, the approach works best when systematically employed over a portfolio of opportunities, not simply one lone trade. Yet because of the capital and expertise required, merger arbitrage has usually been the bailiwick of hedge funds and a handful of specialized funds like the Arbitrage Fund, Gabelli ABC Fund or the Merger Fund.

Hypothetical performance of the Credit Suisse Merger Arbitrage Liquid Index Source:

The Merger Money Machine

Credit Suisse

Now, a new exchange-traded note aims to further refine the approach with greater liquidity, transparency and lower costs. The Credit Suisse Merger Arbitrage Liquid Index ETNtracks a dynamic basket of large-cap, actively-traded merger deals among Northern American and European companies. Using a rules-based index, the exchange-traded note charges an annual fee of 0.55%, compared to 0.66% for Gabelli ABC Fund, 1.54% for Merger Fund and 1.63% for Arbitrage Fund.

Correlation using monthly returns (9/1/2005-8/31/10) Source: Credit Suisse

Credit Suisse Merger Arbitrage Liquid Index (CSMA)

For investors searching for absolute return strategies and not simply stock exposure, the note merits a closer look. Using back tested data, the index would have returned 6.54% a year over the past five years, and because merger arbitrage doesn t depend on the market necessarily rising or falling, the strategy boasts a low 0.62 correlation to the S&P 500 and a 0.30 correlation to the bond market.

In bull markets, any sort of hedged or market-neutral approach quickly gets left behind. But as more investors enter or near retirement, you ll continue to see an even bigger emphasis put on alpha-generating strategies which don t require an upward move in the markets to be profitable. Now available off-the-shelf as an exchange-traded-note, merger arbitrage can be easily dropped into portfolios that would never previously had the time, expertise or capital to participate in this once-esoteric approach.