‘The level of trust is through the roof’

Wall Street has a new investment. And while financiers can make big profits, there are reasons for mom-and-pop investors to tread lightly.

The investments – SPACs, or special acquisitions – 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. Thus, the private company is traded in public. If there is no agreement within the specified time limit, investors get their money back.

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Proponents of SPAC see it as a form of venture capital that investors can get a piece of growing businesses early in the start. There is also a degree of loss protection, depending on when investors buy.

But SPACs are also known as ‘blank check’ funds, because investors give money to a manager without knowing which company they can eventually acquire. Managers can identify specific targets for the industry or business in the initial submission, but they are not required to pursue them, which essentially gives them a map.

In some cases, investors can buy the star power of a manager.

The list of SPAC sponsors includes, for example: Bill Ackman, the well-known hedge fund manager; former House Speaker Paul Ryan; former Trump economic adviser Gary Cohn; and sports icons such as Shaquille O’Neal, Alex Rodriguez and Colin Kaepernick.

“You invest in people,” said Michael McClary, chief investment officer at ValMark Financial Group. ‘The level of trust is through the roof.

‘At the moment we are sitting [SPACs] in a bucket of gold and bitcoin, “he added. This is very speculative. And there is no financial analysis you can really do. ‘

The investment pools are not new. But they have become popular.

SPAC’s initial offer doubled to 248 last year, according to Jay Ritter, a professor of finance at the University of Florida. The IPOs will be expanded again in 2021, he said.

They raised nearly $ 26 billion last month, a record.

“The market is exploding,” Ritter said.

Retail investors seem to be driving a large part of the madness – as with other recent manias like GameStop shares.

But the video game retailer is offering a warning to investors trying to cash in on a hot-ticket item: the stock has risen 1,700% in less than a month; he immediately lost most (85%) of its value in the next two weeks.

In the case of SPACs, retail investors seem to be chasing the returns of the past, according to Ritter.

SPACs listed this year had an average return on the first day of 6.1% – about six times the average in 2003-20, Ritter said.

““If it has not gone so well in the last six months, I do not think we would have seen this boom, ‘he said.

According to financial experts, there are reasons for caution.

More and more mom-and-pop investors are not buying shares at SPACs’ initial listing price, Ritter said. (They usually accept $ 10 per share.) Retail investors who do not come in early do not participate as much or at all in the initial share price.

An important selling point of SPACs was their money back guarantee, which limits the negative risk. Investors may choose to redeem their shares when a merger or acquisition is announced, rather than becoming shareholders in the combined entity.

However, investors will not necessarily recover everything. They are entitled to $ 10 per share plus interest. If they bought higher prices on the open market – say for $ 12 – they would take a loss (about $ 2 per share, in this example). Shares in the combined entity may also fall below $ 10 when they start trading.

“As with anything, there can be some risks,” said Marguerita Cheng, a certified financial planner and CEO of Blue Ocean Global Wealth in Gaithersburg, Maryland. “It’s not suitable for everyone in every situation.”

Yields, according to experts, were also not great when measured by standard measures.

The typical buy-and-hold SPAC investor earned a gross return of 45% between January 2019 and 2021, writes Michael Cembalest in a recent JPMorgan analyst letter. (The analysis measures returns for the median investor.)

However, investors would have earned a higher return in the S&P 500 stock index, which returned 52% over the same period.

‘Good absolute returns so far, but in bull stock markets the tides are raising all boats,’ says Cembalest, chairman of JP Morgan Asset Management’s marketing and investment strategy, which suggests that SPACs are a strong stock in a strong stock market. has.

The typical SPAC fund manager also made a lot more money than investors – according to Cembalest, this is a return of 682% over the two years.

This is partly due to the structure of the funds: managers usually get a 20% stake in the acquired company at low upfront costs. However, they get nothing if an agreement is not realized.

They therefore have an incentive to enter into transactions. It can be harder to get well in a market that is flooded with investor capital.

“The SPAC boom could eventually bring much earlier, much riskier companies to market,” according to Cembalest.