Bare check funds are hot, but can be risky: “The level of trust goes through the roof”
Shaquille O’Neal speaks in New York during Sports Illustrated Sportsman of the Year 2019. O’Neal is serving as strategic advisor to a $ 250 million SPAC.
Bennett Raglin | Getty Images Entertainment | Getty Images
Wall Street has a new investment, darling. And while financiers can make big profits, there are reasons for mom and pop investors to be frivolous.
The investments – SPACs or special purpose vehicles – 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.
SPAC sponsors include: 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.
“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’re betting [SPACs] in a bucket of gold and bitcoin, “he added.” It is 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 are set to quadruple again in 2021, he said.
They raised nearly $ 26 billion last month, a record.
“The market is exploding,” said Ritter.
The SPAC boom could lead to 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 – just like with 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; it immediately lost most (85%) of its value over the next two weeks.
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 day one – about six times the average over the period 2003-2020, Ritter said.
“”If things hadn’t gone so well in the past 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 get that 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.
However, investors are not necessarily going to make amends. 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 2019 and 2021, Michael Cembalest wrote in a recent JPMorgan analyst report. (The analysis measures the return for the median investor.)
However, investors would have received 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 – a return of 682% over that two-year time horizon, according to Cembalest.
This is partly due to the structure of the funds: Managers typically receive a 20% stake in the acquired company at low up-front costs. You don’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 many earlier, much riskier companies being launched,” said Cembalest.