Venture capitalist Chamath Palihapitiya.
Mark Kauzlarich / Bloomberg via Getty Images
Blank check funds are hot. Wall Street investors are increasingly betting against them.
Short positions in Special Purpose Acquisition Companies (SPACs) are $ 2.7 billion, more than three times the $ 765 million at the end of 2020, according to S3 Partners, who track financial data.
Unlike a typical stock investor, short sellers benefit when a company’s stock price falls.
According to S3, short interest has risen as SPAC stocks have risen. Traders are interested in such an exposure in an overbought area of the market, the company said.
What are SPACs?
SPACs are similar to quasi-IPOs.
A publicly traded Shell company uses investor money to buy or merge with a private company, usually within two years. This is how the private company is listed on the stock exchange. If no deal is concluded within the specified period, investors get their money back.
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SPAC proponents see it as a form of venture capital that investors can use to get a piece of high-growth start-up early on. There is also some protection against loss depending on when investors buy in.
However, SPACs are also known as “blank check” funds because investors give money to a manager without knowing which company they will ultimately get. Managers can identify specific industry or business goals in the initial filings, but are not required to pursue them and are essentially giving them carte blanche.
In some cases, investors can buy the star power of a manager.
The list of SPAC sponsors includes: Bill Ackman, the renowned hedge fund manager; former House Speaker Paul Ryan; Ex-Trump economic advisor Gary Cohn; and sports icons like Shaquille O’Neal, Alex Rodriguez and Colin Kaepernick.
The heavily shortened SPACs include those backed by high profile investors like venture capitalist Chamath Palihapitiya, according to the Wall Street Journal.
“You invest in people,” said Michael McClary, chief investment officer, ValMark Financial Group. “The level of trust goes through the roof.
“At the moment we are betting [SPACs] in a bucket of gold and bitcoin, “he added.” It’s highly speculative. And there is no financial analysis that you can actually do. “
The investment pools are not new. But they have become more popular.
According to Jay Ritter, a finance professor at the University of Florida, SPAC initial offers quadrupled to 248 over the past year. The IPOs should quadruple again in 2021, he said.
“The market is exploding,” said Ritter.
The SPAC boom could result in many earlier, much riskier companies entering the market.
Chairman of Market and Investment Strategy for JP Morgan Asset Management
Retail investors seem to be driving much of the frenzy – as has other recent manias like GameStop stock.
However, the video game retailer offers a cautionary story for investors trying to profit from a hot-ticket article: the stock rose 1,700% in less than a month and immediately lost the majority (85%) over the next two weeks. ) their worth.
In the case of SPACs, retail investors seem to be chasing past returns, according to Ritter.
The SPACs listed this year achieved an average return of 6.1% on the first day – about six times the average in the period from 2003 to 2020, said Ritter.
“”If things hadn’t gone so well in the last six months, we probably wouldn’t see this boom, “he said.
Reasons for caution
According to financial experts, there are reasons to be careful.
More and more mom and pop investors are not buying shares at the initial listing price of SPACs, Ritter said. (They usually trade at $ 10 per share.) Retail investors who don’t get in early won’t take as much – or any – part of this initial stock price pop.
A major selling point from SPACs was their money-back guarantee, which limits downside risk. Investors can redeem their shares upon a merger or acquisition announcement instead of becoming shareholders in the combined company.
Investors are not necessarily going to make amends, however. You are entitled to $ 10 per share plus some interest. If they bought higher priced stocks on the open market – for example, for $ 12 – they would suffer a loss (around $ 2 per share in this example). The combined company’s shares may also drop below $ 10 at the start of trading.
“As with anything, there could be some risk,” said Marguerita Cheng, certified financial planner and CEO of Blue Ocean Global Wealth in Gaithersburg, Maryland. “They are not for everyone in every situation.”
According to experts, the returns were not outstanding even when compared to standard benchmarks.
The typical buy-and-hold SPAC investor achieved a gross return of 45% between January 1, 2019 and January 22, 2021, Michael Cembalest wrote in a recent JPMorgan analyst report. (The analysis measures the return for the median investor.)
However, investors would have had a higher return on the S&P 500 stock index, which had a return of 52% over the same period.
“Good absolute returns so far, but rising tides are lifting all boats in bull stock markets,” said Cembalest, chairman of market and investment strategy for JP Morgan Asset Management, suggesting that SPACs piggyback on a strong stock market.
The typical SPAC fund manager also made far more money than investors – according to Cembalest, a return of 682% over that two-year time horizon.
This is partly due to the fund structure: Managers typically receive a 20% stake in the company they acquire at low up-front costs. You won’t get anything if a deal doesn’t go through.
They therefore have an incentive to do business. Good ones may be harder to come by in a market flooded with investor capital.
“The SPAC boom could result in the launch of many earlier, much riskier companies,” said Cembalest.