Short sellers are betting more against SPACs

Blank check funds are hot. Wall Street investors are increasingly betting against them.

Short positions in special purpose acquisition companies, or SPACs, are $ 2.7 billion, more than triple the $ 765 million at the end of 2020, according to S3 Partners, which tracks financial data.

Unlike a typical stock investor, short sellers profit when a company’s stock price falls.

Interest sold went up with the appreciation of SPAC shares, according to S3. There is significant interest among traders in obtaining such exposure in an overbought area of ​​the market, the company said.

SPACs are like almost IPOs.

A publicly traded front company uses the investor’s money to buy or merge with a private company, usually within two years. In doing so, the private company becomes publicly traded. If there is no deal within the specified timeframe, investors get their money back.

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Proponents of SPAC see them as a form of venture capital that can allow investors to get a share of high-growth start-ups at an early stage. There is also some protection against losses, depending on when investors buy.

But SPACs are also known as “blank check” funds – because investors give money to a manager without knowing what company they can buy. Managers can identify specific industry or business targets in the initial records, but are not required to pursue them, essentially giving them carte blanche.

In some cases, investors may purchase star power from a manager.

SPAC’s list of sponsors includes, for example: Bill Ackman, the renowned hedge fund manager; former mayor Paul Ryan; Gary Cohn, former Trump economic adviser; and sports icons like Shaquille O’Neal, Alex Rodriguez and Colin Kaepernick.

Among the heavily sold SPACs are those supported by high-profile investors, such as venture capitalist Chamath Palihapitiya, according to The Wall Street Journal.

“You are investing in people,” said Michael McClary, chief investment officer at ValMark Financial Group. “The level of confidence is high.

“At the moment, we are putting [SPACs] in a bucket with gold and bitcoin, “he added.” It is highly speculative. And there is no financial analysis that you can actually do. “

Investment pools are not new. But they have grown in popularity.

Initial SPAC offerings quadrupled last year to 248, according to Jay Ritter, a professor of finance at the University of Florida. IPOs are on track to quadruple again in 2021, he said.

“The market is exploding,” said Ritter.

Retail investors seem to be driving much of the frenzy – as they have done with other recent fads, such as GameStop’s stock.

But the video game retailer offers a warning story for investors trying to capitalize on a high-value item: shares rose 1,700% in less than a month, then promptly lost most (85%) of their value in two weeks. following.

In the case of SPACs, retail investors appear to be looking for previous returns, according to Ritter.

The SPACs listed this year had an average return of 6.1% on the first day – about six times the average from 2003 to 2020, said Ritter.

“If things hadn’t gone so well in the past six months, I don’t think we’d see this boom, “he said.

There are reasons for caution, according to financial experts.

Increasingly, retail investors are not buying shares for the initial listing price of SPACs, said Ritter. (They tend to be quoted at $ 10 per share.) Retail investors who do not enter the market in advance will not participate as much – or in any way – in the initial stock price increase.

A key selling point for SPACs has been the money-back guarantee, which limits the risk of falling. Investors may choose to redeem their shares when a merger or acquisition is announced, rather than becoming shareholders of the combined entity.

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

“As with anything, there can be some risks,” said Marguerita Cheng, certified financial planner and CEO of Blue Ocean Global Wealth in Gaithersburg, Maryland. “They are not suitable for everyone in all situations.”

The returns were also not stellar when measured against standard benchmarks, according to experts.

The typical SPAC purchase and maintenance investor achieved a 45% gross return between January 1, 2019 and January 22, 2021, wrote Michael Cembalest in a recent analyst note from JPMorgan. (The analysis measures returns for the average investor.)

However, investors would have obtained a higher return on the S&P 500 stock index, which yielded 52% in the same period.

“Good absolute returns so far, but in bullish stock markets, rising tides lift all boats,” said Cembalest, president of market and investment strategy at JP Morgan Asset Management, suggesting that SPACs are hitchhiking on a strong stock market.

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

This is partly due to the structure of the funds: managers usually obtain a 20% stake in the acquired company for a small initial cost. They get nothing if a deal doesn’t go through, however.

Therefore, they have an incentive to do business. The good ones can be more difficult to find in a market flooded with investor capital.

“The SPAC boom may end up bringing to the market many companies in earlier and much more risky stages,” according to Cembalest.