Short sellers bet more against SPACs

Blank checks are hot. Wall Street investors are increasingly gambling against them.

Short positions in specialty acquisition companies, or SPACs, are $ 2.7 billion, more than three times the $ 765 million at the end of 2020, according to S3 Partners, which tracks financial records.

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

According to S3, short-term interest rates have risen as shares of SPAC have risen. There is a lot of interest among traders to gain such exposure in an overbought part of the market, the company said.

SPACs are a kind of quasi-IPO.

A publicly traded shell company uses investor money to buy or merge with a private company, usually within two years. As a result, the private company is listed on the stock exchange. If there is no deal within the deadline, investors will get their money back.

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Proponents of SPAC see them as a form of venture capital that allows investors to get a piece of fast-growing start-ups at an early stage. There is also some protection against loss depending on when investors buy in.

But SPACs are also known as “blank check” funds – because investors give money to a manager without knowing which company to eventually acquire. Managers can identify specific industry or company goals in the initial sign-ups, but are not required to pursue them, effectively giving them carte blanche.

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

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

According to The Wall Street Journal, among the heavily shorted SPACs backed by leading investors include venture capitalist Chamath Palihapitiya.

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

“Right now we put [SPACs] in a bucket of gold and bitcoin, “he added.” It’s highly speculative. And there is no financial analysis you can actually do. “

The investment pools are not new. But they have skyrocketed in popularity.

According to Jay Ritter, a professor of finance at the University of Florida, the original SPAC offering quadrupled to 248 last year. IPOs are on track to quadruple again by 2021, he said.

“The market is exploding,” said Ritter.

Retail investors seem to be driving a lot of the madness – as they did with other recent manias like GameStop stocks.

But the video game retailer offers a cautionary tale for investors trying to take advantage of a hot ticket item: the stock rose 1,700% in less than a month, then immediately lost most (85%) of its value in the next two weeks.

In the case of SPACs, private investors seem to be looking for past returns, according to Ritter.

SPACs listed this year had an average first-day return of 6.1% – about six times the average over the 2003-2020 period, Ritter said.

If it hadn’t gone so well in the last six months, I don’t think we would be experiencing this boom, ”he said.

There are reasons for caution, financial experts said.

More and more mom-and-pop investors are not buying stock at SPAC’s original listing price, Ritter said. (They typically quote $ 10 per share.) Private investors who don’t get in early will not participate as much, if at all, at that initial share price.

A major selling point of SPACs was their money-back guarantee, which limits downside risk. Investors may choose to repurchase their shares when a merger or acquisition is announced, rather than becoming shareholders in the combined entity.

However, investors will not necessarily recoup everything. They are entitled to $ 10 per share plus some interest. If they were to buy more expensive stocks in the open market, say for $ 12, they would be in a loss (about $ 2 per share in this example). Shares in the combined entity can also fall below $ 10 when they start trading.

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

According to experts, returns were also not great compared to standard benchmarks.

The typical buy-and-hold SPAC investor achieved a gross return of 45% between Jan. 1, 2019 and Jan. 22, 2021, Michael Cembalest wrote in a recent JPMorgan analyst note. (The analysis measures returns for the median investor.)

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

“Good absolute returns so far, but in rising stock markets the rising tide is bringing all the boats up,” said Cembalest, JP Morgan Asset Management’s chairman of market and investment strategy.

The typical SPAC fund manager also made a lot 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 get a 20% stake in the acquired company for a small upfront payment. However, they get nothing if there is no deal.

So they have an incentive to make deals. Good ones may be harder to find in a market overrun with investor capital.

“The SPAC boom could lead to much earlier, much riskier companies entering the market,” said Cembalest.