So, you think you’re SPAC-cial
“Beware of geeks bearing formulas”
This quote was taken from a letter that Warren Buffett wrote to his shareholders in 2009. In it, he discussed the collapse of the US housing market being caused by products linked to complex mathematical models which did not take into account some worst case scenarios. It is simple advice to follow especially when it comes to investing — Don’t buy anything you don’t understand; if the person selling it to you can’t explain it clearly in simple English, then it is wise to have a second opinion on it.
The investment world is fond of acronyms — ETF. ELN. IPO. EPS. MLP. SIBOR. etc. — trying to understand them all can be confusing. SPAC, the latest one gaining popularity, stands for Special Purpose Acquisition Company, and it is the latest, hottest trend in the financial industry in the past year.
A SPAC is an investment vehicle whose main function is providing the means to take a private company public. Private companies have several choices if they want to go public and, historically, many have undergone their own initial public offerings (IPOs).
With a SPAC, the sponsor (typically a well known personality) raises assets through its own SPAC IPO with the intent of using the proceeds to purchase a yet-to-be-identified private company that is later “acquired” and effectively taken public. The sponsor typically will define a period to the investors in which to find and acquire the potential target company, otherwise, cash from the IPO is returned to investors. If the SPAC acquires a private company, the investors in the SPAC are given an option of redeeming their shares for cash or to become a shareholder in the new operating company.
SPACs are not new, but have only recently exploded onto the scene. In comparison, from 2013 to 2019, traditional IPOs raised almost $268 billion versus just $43 billion in SPACs. However, in 2020 SPAC issuance exploded to almost 250 listings totalling more than $83 billion. This trend has continued in 2021, with an additional 165 SPAC IPOs totalling almost $98 billion to date.
Will investing in SPACs provide us with the returns that are owed? The answer is: it depends.
While you may have seen headlines about large business combinations and some outsized returns, the comprehensive data paints a different picture. A recent study from Stanford and NYU analysed all 47 SPACs that merged between January 2019 and June 2020. The authors found that while the returns across SPACs varied widely, the average absolute returns (both median and mean) and relative returns versus an IPO Index and the Russell 2000® Index (a US market small-cap benchmark) were all negative in the 3-, 6- and 12-month periods following the SPAC merger (see chart below).
The SPAC craze is reaching Singapore’s shores with the SGX recently launching a consultation on it and local company Grab announcing a $40bn merger with a US-listed SPAC. Some proposals are seeking to address some inherent risks and to try to better align it with shareholder interests. However, if you are looking to invest in one of these vehicles, some common-sense investment principles should apply. The terms of each deal, your rights as an investor, the sponsor’s incentives, etc., all play a part in determining if a SPAC may be a viable investment for you. Even if everything lines up, it ultimately remains an investment in a single company, so the outcome is based almost entirely on the ability of that company to succeed.
Diversification is one of the most basic principles of investing; its benefits are always worth remembering. Success in investing is not dependent on picking the best single company. Over the long-term, the history of markets have shown that globally diversified investors with an optimal risk-return ratio are rewarded with consistent returns.
