‘The trust level is through the roof’

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

The investments – SPACs or special acquisition companies – resemble quasi-IPOs:

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 initial applications, but are not required to pursue them, effectively giving them carte blanche.

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

The selection of SPAC sponsors includes, for example: Bill Ackman, 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.

“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.

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

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

“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 to investors trying to take advantage of a hot-ticket item: stock surged 1,700% in less than a month; it promptly lost most (85%) of its value over the next two weeks.

In the case of SPACs, retail 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 2003-20 average, 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 say.

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

Investors will not necessarily recoup everything, however. 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 may be some 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 January 2019 and 2021, Michael Cembalest wrote in a recent analyst note from JPMorgan. (The analysis measures returns for the average investor.)

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

“So far good absolute returns, 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 usually receive 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 many earlier, much riskier companies entering the market,” said Cembalest.