Sophisticated investors have been hiding from inflation and volatility — in the cash-like safety of pre-merger SPACs


Of all the places where savvy investors have been looking for coverage of high inflation and large fluctuations in the financial market over the past year, there is a surprise option: special purpose acquisition companies or SPAC.

The number of new SPACs reaching the stage of issuing their own initial public offerings has dropped dramatically, from 613 in 2021 to 248 in 2020 to 67 this year, according to SPAC Research. This bear market has created a compelling case for some investors to take advantage of the overabundance of SPACs that are nearing the end of their two-year life and are still looking for a deal. One estimate puts the amount of arbitrage benefits that can be obtained with overfunded SPAC trusts at more than $ 4.3 billion, as long as investors buy at or below the value of the net asset of a SPAC.

The key word behind this approach is arbitrage, or the ability to exploit different markets. An arbitrage move focuses on the pre-merger stage of the SPAC: when the intact capital is in a trust, gaining interest in Treasury bills, with the option to raise a quote growing share of SPAC shares when an attractive merger is announced. Another move takes place at a time when SPAC shares are redeemed, either with the shareholders ’vote on a merger or liquidation of SPAC.

Amar Pandya, a Vancouver-based PenderFund Capital Management portfolio manager, expects the vast majority of SPACs to be unsuccessful in finding targets, forcing them to return their initial income plus interest to investors.

It is the prospect of a return that investors are longing for right now, given the sale of 2022 stocks and bonds, wild volatility and growing fears of stagnation. During the 18 months to two years it could take to find a target and complete a merger, SPACs must keep the initial public offering revenue in risk-free instruments, i.e. Treasury bills, while accruing interest. This feature of the SPAC structure is designed to provide a safety net regardless of whether a target company is found, investors like the target or if the SPAC fails and is forced to liquidate.

In SPAC arbitration, “if the sponsor finds a goal is not a critical element of the strategy,” said Mark Yusko, CEO and chief investment officer of Morgan Creek Capital Management in Chapel Hill, North Carolina. oversees about $ 2.2 billion. “All we care about is getting our capital and interests from the Trust Treasury and, over time, investing in a series of SPACs where the post-merger combined entity’s warrants have some bullish potential.” .

“The key case why an investor would want to have arbitrage in their portfolio has absolutely improved,” Yusko told MarketWatch. “SPAC arbitrage is significantly safer than bonds or stocks.”

Morgan Creek and Exos Financial manage a $ 60 million SPAC arbitrage hedge fund called the SPAC + fund as an alternative to fixed income. The fund produced 18% in the first half of 2020 and 11% in 2021, according to the fund’s materials posted on the Morgan Creek website. This year’s performance numbers have not been made public, but were around 2% until April, and the privately run hedge fund is not required to apply to the Securities and Exchange Commission. .

Morgan Creek-Exos released a version of the ETF fund, or exchange-traded fund, called Morgan Creek-Exos Active SPAC Arbitrage ETF CSH,
-0.07%,
in February, open up the arbitrage strategy to retail investors.

SPACs first emerged in their current form in 2003 and have long used short-term U.S. government securities as a safe place to park their pre-merger IPO revenues. . What is different now is that the increase in regulatory control along with the bursting of the SPAC bubble in 2021 has not affected the enthusiasm of some investors, who still consider SPACs to be a safer alternative to stocks or stocks. fixed income. This is true even though Goldman Sachs Group Inc. GS,
+ 2.40%
and other large banks are withdrawing from the SPAC market amid a slew of regulatory proposals. Critics have called SPAC a “scam.”

Simply put, SPACs, also known as blank check companies, are fictitious corporations that are listed on a stock exchange for the sole purpose of acquiring or merging with a private company and making it public.

“With volatile markets, rising inflation and rising interest rates, there have not been many hiding places in the market. SPAC arbitrage offers a unique and low-risk opportunity for investors to get an attractive return. “


– Amar Pandya of PenderFund Capital Management

With SPAC shares being traded at a discount in their trust cash, the potential advantage for buyers, or the benefit of arbitrage, is more than $ 4.3 billion as of Monday, according to Accelerate, a provider of alternative investment strategies for Calgary-based retail investors. Currently, the company said, 98.2% of SPACs trade at a discount on their net asset value, offering an average arbitrage yield of 4.8%.

“SPAC arbitrage is perhaps the highest risk and reward proposition on the market today,” says Julian Klymochko, CEO of Accelerate, which created the $ 40 million Accelerate Arbitration Fund. The fund reported an annual return of 7.4% for 2021 on its Canadian regulatory filing and an annualized return of 16.9% from its inception in 2020 to April 29 this year in its most recent fact sheet.

Klymochko points to Digital World Acquisition Corp. DWAC,
-1.67%,
SPAC plans to release Trump Media & Technology Group. Any investor who bought SPAC at $ 10 a share did so at a “zero disadvantage,” he says. SPAC shares were trading at $ 45.15 each on Tuesday afternoon.

“It hasn’t looked too good for stocks or bonds, and investors need alternatives – they’re looking for alternative asset classes that give them a chance of positive returns,” Klymochko told MarketWatch.

Given the more than 600 SPACs still looking for a target, the market is putting the price on the prospect that more than 400 will end up being liquidated, according to Klymochko. And that’s okay for arbitrage, “considering we still make money (as long as we’re buying below the NAV),” he said by email.

SPAC Research data show that $ 162.1 billion linked to 602 SPACs seeking targets are in trusts, most of which are invested in the Treasury market.

Of course, SPACs are not the only place investors hide: they will also go in cash, Treasury bills, certificates of deposit, money market funds and I bonds. And SPAC arbitrage is not without its own risks. . These risks may include limited liquidity, the potential for fraud instead of trust, and the potential to reduce the potential for upside if a poorly received acquisition target is announced.

Reads: “Is there no place to hide?” What happens next when stocks fall to the bearish market amid fears of stagnation

However, the perception of SPACs as a safe haven marks a turning point from the more common view that has prevailed in recent years as a vehicle of rapid wealth for investors. Investors typically pay around $ 10 for a single SPAC unit on the SPAC’s IPO, which consists of a common share and a fraction of a warrant. Warrants offer the option to buy more shares in the future, at a set price.

PenderFund’s Pandya, which manages $ 2.4 billion, manages the $ 25 million Pender Alternative Arbitration Fund. PenderFund declined to discuss the performance of the arbitrage fund because it has only been in existence for less than a year, but Morningstar’s profile on Monday showed a year-to-date return of minus 0.88% and a subsequent return. of 1.16% since the launch of the fund in September. Seventy percent of the fund is invested in merger arbitration, while the other 30% is invested directly in SPAC arbitration, with a preference for SPACs approaching the end of their two-year life.

Pandya said he sees a limit to how long the SPAC arbitrage strategy can last and estimates that there are only three or four more quarters left before the SPAC market “finds its balance” as the whole of SPAC shrinks. and more goals are available.

“With volatile markets, rising inflation and rising interest rates, there have not been many hiding places in the market,” Pandya said by telephone. “SPAC arbitrage offers a unique and low-risk opportunity for investors to get an attractive return.”



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