Short sellers are betting more against SPACs –

Short sellers are betting more against SPACs

Venture capitalist Chamath Palihapitiya.

Mark Kauzlarich / Bloomberg via Getty Images

Blank check funds are hot. Investors on Wall Street are increasingly betting against him.

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 benefit when the price of a company’s stock drops.

Short interest has risen as SPAC shares have rallied, according to S3. There has been great interest among traders to gain such exposure in an overbought area of ​​the market, the firm said.

What are the SPACs?

SPACs are a kind of quasi-IPO.

A public shell company uses investors’ money to buy or merge with a private company, usually within two years. By doing so, the private company goes public. If there is no deal within the specified time limit, investors get their money back.

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SPAC proponents see them as a form of venture capital that can allow investors to get a share of high-growth startups at an early stage. There is also some protection against loss, 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 ultimately acquire. Managers can identify specific business or industry goals in initial introductions, but are not required to pursue them, essentially giving them carte blanche.

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

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

Very short SPACs include those backed by high-profile investors like venture capitalist Chamath Palihapitiya, according to The Wall Street Journal.

“You’re investing in people,” said Michael McClary, chief investment officer at ValMark Financial Group. “The confidence level is through the roof.

“Right now, we are putting [SPACs] in a bucket with gold and bitcoins, “he added.” It is very speculative. And there is no financial analysis that you can really do. “

‘Explosive’ market

Mutual funds are not new. But they have skyrocketed in popularity.

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

“The market is exploding,” Ritter said.

The rise of SPAC may end up bringing many earlier-stage and much riskier companies to market.

Michael Cembalest

President of Market and Investment Strategy, JP Morgan Asset Management

Retail investors appear to be driving much of the frenzy, as they have with other recent crazes like GameStop stocks.

But the video game retailer offers a cautionary tale for investors trying to capitalize on a hot item: Stocks jumped 1,700% in less than a month, then quickly lost most (85%) of their value in the next two weeks.

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

The 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 things hadn’t gone so well in the last six months, I don’t think we would be seeing this boom, “he said.

Reasons for caution

There are reasons to be cautious, according to financial experts.

More and more family investors are not buying shares at the initial listing price of SPACs, Ritter said. (They typically trade at $ 10 a share.) Retail investors who don’t get in early won’t participate as much, or at all, in that initial stock price surge.

A key selling point of SPACs has been their money-back guarantee, which limits downside risk. Investors can 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 get everything back. They are entitled to $ 10 per share plus some interest. If they bought higher priced stocks on the open market, say, for $ 12, they would take a loss (about $ 2 per share, in this example). Shares of the combined entity may also drop below $ 10 when they begin trading.

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

SPAC returns

The returns haven’t been stellar either when compared to standard benchmarks, according to experts.

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

However, investors would have outperformed the S&P 500 stock index, which returned 52% over the same time period.

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

The typical SPAC fund manager also made significantly more money than investors – a return of 682% over that two-year time horizon, according to Cembalest.

That’s partly due to the structure of the funds: Managers typically get a 20% stake in the acquired company for a small upfront cost. However, they get nothing if a deal doesn’t materialize.

Therefore, they have an incentive to make deals. The good ones can be harder to come by in a market awash with investment capital.

“The rise of SPAC may end up bringing many earlier-stage and much riskier companies to the market,” according to Cembalest.


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