Special-purpose acquisition companies, commonly referred to as SPACs, are all the rage as institutional and individual investors alike want to find the next big company to pile their money in.
These are shell companies (or blank-check companies) with no existing operations, created for the sole purpose of raising money through an initial public offering to find and purchase a private company that it eventually acquires.
SPACs have risen in prominence in the last year, taking a high volume of private companies public. But their popularity has come with scrutiny. The U.S. Securities and Exchange Commission is seeking to crack down on SPAC activity, examining things such as SPACs making lifted forward-looking projections and modified disclosures, among other examinations, to ensure investors are protected.
Retail investors have historically been shut out of investing in private companies, but SPACs offer an opportunity for average investors to invest in pre-IPO companies by investing in a public venture capital-like firm with industry-specific expertise that will find these opportunities for you.
One way to invest in SPACs is through SPAC exchange-traded funds, a slightly less risky method of gaining exposure as opposed to investing directly in a SPAC. Among the hundreds of SPACs out there, not all of them will be winners. SPAC ETFs offer diversified exposure to the asset class, while limiting downside risk for companies that won't come around to make a deal.
As a general rule of thumb for interested SPAC investors, it's important to be invested in many SPACs because you don't know which ones will pop or flop.
Since most SPACs were created in 2020, the end of their two-year window is quickly approaching at the end of 2021 or early 2022, says Iliya Rybchin, partner at Elixirr, a management consulting firm that works with SPACs.
"A SPAC that hits the window and has not yet acquired a company will need to fold and return capital to investors," Rybchin says. "This will cause (the) share price to drop significantly."
Given that a majority of SPACs are having trouble finding companies to acquire, resulting in more SPACs going after target companies, Rybchin says "it's likely that many SPACs will hit the two-year window before finding an acquisition."
An ETF is a great instrument for SPAC investing because you have diversified exposure through a broad portfolio of SPAC deals, reducing your investment risk. Currently, there are three SPAC ETFs on the market, each with benefits and pitfalls.
Evan Ratner, portfolio manager at Easterly Investment Partners, cites several features for successful investment in this asset class – including low expense ratios, the availability of warrants, investments in a relatively concentrated number of SPACs and the ability to hold investments long enough to gain upside in profitable public companies. Here are the three SPAC ETFs that are trading on the market:
- Defiance Next Gen SPAC Derived ETF (SPAK).
- SPAC and New Issue ETF (SPCX).
- Morgan Creek Exos SPAC Originated ETF (SPXZ).
Defiance Next Gen SPAC Derived ETF
SPAK (SPAK) is the first SPAC ETF to ever hit the market, launching in September 2020.
This is a great ETF for investors who want exposure to the entire IPO market. The ETF is passively managed, which helps lower the expense ratio to 0.45%, making it the cheapest SPAC ETF on the market.
Defiance acknowledges that picking winners is not easy, which why it chooses SPACs based on innovation, liquidity and market capitalization in a diversified basket of constituents.
SPAK comes with more than 200 holdings, with its highest weighting on post-SPAC deals, at a 60% allocation, and 40% allocation toward the blank-check companies at the pre-stage deal. This could be a way for investors to access returns both from the SPAC and from the stock's potential return after it hits the market.
The fund holds $70 million worth of assets. Top holdings include DraftKings (DKNG), which is up more than 230% year over year; Pershing Square Tontine, the SPAC led by Bill Ackman, Churchill Capital Corp. (CCIV) and Richard Branson's Virgin Galactic (SPCE), to name a few.
Some of the requirements to be included and to maintain a spot in Definace's SPAC ETF include a minimum market cap of $250 million and trading volume of 1 million shares a day for the past three months. SPAK is down by about 4% since its inception.
SPAC and New Issue ETF
SPCX (SPCX), the first actively managed SPAC ETF, brought to market in December 2020, is managed by Tuttle Capital Management. The fund currently has around 100 holdings, net assets valued at more than $169 million and an expense ratio of 0.95%.
SPCX invests in SPACs that have a minimum capitalization of $100 million and companies that have completed an IPO within the last two years.
The fund takes an active management approach to accommodate the rapidly changing SPAC market. SPCX may buy SPACs before a merger agreement is made and sell SPACs when a SPAC business announcement is made or when the price increases to make room to invest in new, pre-merger SPACs. Active management may lead to high portfolio turnover rates, which could result in more costs for investors.
Taking an active approach helps manage risk, says Patrick Galley, CEO and chief investment officer at RiverNorth Capital Management, an investment management firm based in Chicago.
"It's worth taking an active approach based off of the premium or discount that a SPAC is trading to its trust value," Galley explains.
"For premium SPACs, it would be prudent to trim that exposure, and if they're trading at discount, that creates an opportunity to buy," he says.
One important factor investors may want to evaluate is a fund's investment strategy. SPCX only owns SPACs during their two-year life cycle. This is because SPACs have two years to complete a merger with an operating company. This restricts the fund to invest in SPACs, instead of post-merger companies.
SPCX's investing strategy is what differentiates it from its competitors. Since its inception, the fund has returned about 14%, outperforming its peers.
Morgan Creek Exos SPAC Originated ETF
SPXZ (SPXZ) is managed by both Morgan Creek Capital Management and financial technology firm Exos Asset Management and has an expense ratio of 1%, the highest cost among the three listed SPAC ETFs.
SPXZ is a smaller SPAC ETF, with about $44 million in assets under management, and one of the newer ones to hit the market, making its debut at the end of January. The ETF has more than 90 holdings offering broad exposure to pre- and post-combination SPACs by market cap.
The ETF invests around two-thirds of its dollar-weighted portfolio in about 50 of the largest companies that have gone public through a SPAC merger within the last three years, while the rest are from companies seeking startups.
"While this limits the risk of having too large an investment in any one specific SPAC, investors may want more concentrated bets, given the limited downside in SPAC holdings due to the ability to redeem at trust," Ratner says about SPXZ's investment strategy. A trust account is where the SPAC proceeds are held. As a part of shareholders' redemption rights, investors can redeem their shares if they don't want to own the new combined company. In a scenario where a SPAC doesn't make a business deal, the trust is liquidated and the proceeds are sent back to shareholders.
Like SPCX, SPXZ also takes an actively managed approach, which is key to the ETF's success since not all of the businesses will be winners. Morgan Creek and Exos deploy an active strategy to reduce the risk of exposure to poor-performing companies.
Their focus on high-quality businesses and management teams is key to picking high-growth and innovative companies. Exos' proprietary technology and experience in SPACs can be seen as an advantage. That said, SPXZ is currently down 17% since its inception.
Interested SPAC investors should understand that it's important to be invested in many SPACs because you don't know which ones will pop or flop. An ETF is a great instrument for SPAC investing because you get diversified exposure through a broad portfolio of SPAC deals, reducing your investment risk.
While these investments can be speculative, SPACs and SPAC ETFs offer increased access to private market deals for the average investor. As the spotlight continues to shine on SPACs, it may be a chance for you to see if this asset has a place in your investment portfolio.
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