As fixed income investors grapple with historically tight credit spreads and the ongoing challenge of portfolio diversification, a novel exchange-traded fund (ETF) structure aims to solve what its creators call “the funding problem of diversification.” The approach, known as Return Stacking, allows investors to maintain core exposures while adding alternative strategies without sacrificing existing allocations.
In an interview with The Wealth Advisor’s Scott Martin, Corey Hoffstein, CIO of Newfound Research and Co-founder of Return Stacked® ETFs, discussed how the Return Stacked Bond & Merger Arbitrage ETF (ticker: RSBA) combines U.S. Treasuries exposure with merger-arbitrage strategies to create a distinctive fixed income offering that could serve as an alternative to traditional corporate bonds.
Understanding Return Stacking
The fundamental challenge facing many advisors when introducing new diversifying strategies is the necessity of selling existing positions to make room for new allocations. “Most people want to introduce diversifying asset classes or strategies into their portfolio, but they’re not starting with a blank slate, they’re starting with a 60/40” Hoffstein says. “And the question they have to ask is, ‘Well, what do I have to sell to make room?’”
Traditional diversification approaches create two significant hurdles for advisors and their clients: performance gap risk when new investments underperform sold positions, and behavioral challenges as clients struggle to accept unfamiliar strategies in place of conventional holdings. Both obstacles can undermine portfolio optimization efforts and strain advisor-client relationships.
Return Stacking addresses diversification challenges by allowing investors to maintain their core exposures while adding return streams. “If you invest a dollar, you might get a dollar of core stock or bond exposure with that alternative strategy or asset class layered on top,” Hoffstein explains. “So, you don’t have to sacrifice that core stock and bond exposure anymore.”
By preserving core allocations while adding diversifying strategies, Return Stacking aims to help advisors address both performance concerns and behavioral challenges, potentially leading to more resilient portfolios and stronger client relationships.
RSBA exemplifies the Return Stacking approach in the fixed income space, offering advisors the potential to maintain diversified Treasuries exposure while capturing merger-arbitrage returns. By combining these features, RSBA seeks to offer advisors a way to enhance portfolios without disrupting existing allocations or client comfort levels.
RSBA: A Corporate Bond Alternative
In an environment of historically tight credit spreads, RSBA represents an innovative alternative to traditional corporate bonds. “For every dollar you give us, our aim is to give you a dollar of a diversified U.S. Treasuries portfolio plus a dollar of exposure to a merger-arbitrage strategy,” Hoffstein explains.
The merger-arbitrage component historically has generated returns of “about 200 to 300 basis points above cash,” he adds. While merger-arbitrage strategies have traditionally required investors to sell existing positions to gain exposure, RSBA’s structure eliminates that trade-off by stacking the merger-arbitrage risk premium on top of Treasuries exposure.
For advisors seeking alternatives to corporate bonds in a tight spread environment, RSBA offers a potentially compelling solution by aiming to maintain fixed income exposure while capturing returns from an entirely different risk premium.
Risk Management and Deal Selection
The RSBA ETF tracks an index developed by Alpha Beta, a firm specializing in merger arbitrage, which applies an active, machine-learning-based approach to selecting merger deals. The fund focuses only on announced U.S. deals and evaluates them based on such factors as industry, the quality of the acquiring company, and regulatory risks to assess the likelihood of deal completion.
When a merger is announced, the target company’s stock price typically rises but stays below the acquisition price—this remaining gap, or spread, represents potential profit. However, investors take on the risk that the deal might collapse, causing the stock price to fall back to pre-announcement levels. The potential for earning a return in exchange for accepting that risk defines the merger-arbitrage strategy.
RSBA translates Alpha Beta’s hedge fund strategy into an ETF format, leveraging machine learning to screen 200–250 deals per year and selecting only those with a high probability of closing and an attractive remaining spread. The fund’s systematic selection process is designed to help mitigate risk while optimizing potential returns.
Beyond rigorous deal selection, the fund benefits from the strong legal framework governing U.S. mergers, providing an additional layer of certainty. Hoffstein points to Elon Musk’s 2022 attempt to walk away from his $44 billion Twitter acquisition as a case in point. “The courts ultimately forced him to do it because that’s how strong the corporate law precedent is here,” he notes. The robustness of U.S. corporate law provides a structural advantage that helps protect merger-arbitrage returns even in challenging market conditions.
Treasuries Component and Portfolio Implementation
The Treasury portion of RSBA maintains a straightforward, equal-weighted exposure across various maturities. “When you invest a dollar with us, what we’re going to try to do is give you 25 cents of short-term, intermediate term, sort of longer-term, and very long-term Treasuries—two, five, 10, and long bond Treasury exposure,” Hoffstein notes.
Advisors can implement RSBA in two primary ways within client portfolios. The first approach positions the fund as a corporate bond alternative, particularly relevant in the current credit environment. Hoffstein suggests a 50/50 split between corporate bonds and RSBA to potentially capture diversification benefits while keeping similar long-term return expectations.
The second implementation strategy, which Hoffstein describes as “adult swim,” involves replacing pure Treasury holdings with RSBA to maintain Treasuries while adding the potential for enhanced returns through merger-arbitrage exposure.
This implementation flexibility allows advisors to tailor RSBA’s role within portfolios based on client objectives, risk tolerance, and market conditions, making the fund a versatile tool for fixed income allocation.
The Merger-Arbitrage Advantage
A key differentiator for RSBA is the relatively low correlation between merger-arbitrage returns and traditional fixed income risks. Merger-arbitrage strategies have demonstrated lower correlation with equities than credit, particularly during market drawdowns, while maintaining lower volatility and a correlation to credit of approximately 0.3 to 0.4, Hoffstein points out.
Despite potential reductions in deal flow during economic downturns, the idiosyncratic nature of merger-arbitrage opportunities helps maintain strategy effectiveness across market cycles. The combination of low correlation and structural protections makes merger arbitrage particularly attractive as a potential portfolio diversifier in challenging market environments.
Why Advisors Are Adding RSBA to Client Portfolios
RSBA addresses several key challenges advisors are facing in today’s fixed income markets: the need to maintain core bond exposure while enhancing returns, the search for genuine diversification in an environment of tight credit spreads, and the desire to access alternative strategies without disrupting client comfort levels. By combining Treasuries exposure with merger-arbitrage returns in a single vehicle, RSBA offers advisors a sophisticated tool that can potentially either complement existing corporate bond allocations or serve as a Treasuries replacement seeking enhanced returns. The strategy’s structural protections, low correlation to traditional risks, and straightforward implementation make it particularly relevant for advisors focused on improving portfolio efficiency without sacrificing client comfort or core fixed income exposure.
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Definitions and Disclosures
- Alpha: The excess return of an investment relative to a benchmark.
- Basis point: One-hundredth of a percentage point.
Investors should consider the investment objectives, risks, charges, and expenses carefully before investing. For a prospectus or summary prospectus with this and other information about the Fund, please click here: returnstackedetfs.com. Read the prospectus or summary prospectus carefully before investing.
Investments involve risk. Principal loss is possible. Unlike mutual funds, ETFs may trade at a premium or discount to their net asset value. Brokerage commissions may apply and would reduce returns.
Merger-Arbitrage Risk. Merger-arbitrage investing involves the risk that the outcome of a proposed event, whether it be a merger, reorganization, or other event, will prove incorrect and that the Fund’s return on the investment will be negative, or that the expected event may be delayed or completed on terms other than those originally proposed, which may cause the Fund to lose money or fail to achieve a desired rate of return.
Derivatives Risk. Derivatives are instruments, such as futures contracts, whose value is derived from that of other assets, rates, or indices. The use of derivatives for non-hedging purposes may be considered to carry more risk than other types of investments. Bond Risks. The Fund will be subject to bond and fixed income risks through its investments in U.S. Treasury securities, broad-based bond ETFs, and investments in U.S. Treasury and fixed income futures contracts. Changes in interest rates generally will cause the value of fixed-income and bond instruments held by Fund (or underlying ETFs) to vary inversely to such changes. Credit Risk. Credit risk refers to the possibility that the issuer of a security will not be able to make principal and interest payments when due. Changes in an issuer’s credit rating or the market’s perception of an issuer’s creditworthiness may also affect the value of the Fund’s investment in that issuer. Currency Risk. Currency risk is the risk that changes in currency exchange rates will negatively affect securities denominated in, and/or receiving revenues in, foreign currencies. The liquidity and trading value of foreign currencies could be affected by global economic factors, such as inflation, interest rate levels, and trade balances among countries, as well as the actions of sovereign governments and central banks. Foreign and Emerging Markets Risk. Foreign and emerging market investing involves currency, political and economic risk. Leverage Risk. As part of the Fund’s principal investment strategy, the Fund will make investments in futures contracts to gain long and short exposure across four major asset classes (commodities, currencies, fixed income, and equities). These derivative instruments provide the economic effect of financial leverage by creating additional investment exposure to the underlying instrument, as well as the potential for greater loss. Non-Diversification Risk. The Fund is non-diversified, meaning that it is permitted to invest a larger percentage of its assets in fewer issuers than diversified funds. Underlying ETFs Risk. The Fund will incur higher and duplicative expenses because it invests in bond ETFs. The Fund may also suffer losses due to the investment practices of the underlying bond ETFs. New Fund Risk. The Fund is a recently organized with no operating history. As a result, prospective investors do not have a track record or history on which to base their investment decisions.
High Portfolio Turnover Risk. The Fund may active and frequently trade all or a significant portion of the Fund’s holdings. A high portfolio turnover rate increases transaction costs, which may increase the Fund’s expenses. Illiquid Investments Risk. The Fund may, at times, hold illiquid investments, by virtue of the absence of a readily available market for certain of its investments, or because of legal or contractual restrictions on sales.
Foreside Fund Services, LLC is the distributor for the Funds.
