INVESTED: In Markets, in the Future, and in Society.

A year ago, I wrote an Invested piece that cautioned investors about the misalignments in an increasingly popular investment vehicle called a Special Purpose Acquisition Company (SPAC). For those who are unfamiliar, SPACs are basically publicly traded shell companies which exist solely to merge with private companies allowing these private companies to get access to public capital markets. It is an innovative way to bypass the traditional initial public offering (IPO) route, getting past all the regulatory red tape and disclosures that a company usually has to endure to go public. It goes without saying that
these rules and regulations are probably in place for a reason. However, through this method many poorly managed and potentially fraudulent companies have made their way into the hands of public market investors.

So why would anyone invest in a SPAC? As covered in this article from Institutional Investor, investors in these vehicles are offered an incredible deal, a money back guarantee on their initial $10/unit investment plus shares, and warrants as well as interest on the investment. Investors can essentially vote for or against the IPO, tender their shares for $10 each plus interest, making it a no-lose situation. Additionally, investors are usually able to hold onto warrants in the company even if they redeem their units, getting what’s
effectively a free call option on the newly public company. This is often taken advantage of by hedge funds (aptly referred to as the “SPAC Mafia”) as a way to upside potential with no downside risk at the expense of everyday people who stay as shareholders in the company. As if this wasn’t dilutive enough, SPAC sponsors (those that set up the shell company and seek the acquisition target) usually get about 20 percent of the IPO units as a fee. With a high rate of redemptions, these newly public companies often start off completely cash-strapped and must seek external financing to the detriment of the
remaining shareholders, making it even more difficult for them to succeed. No wonder the 300 companies that have gone public via SPAC in the US since 2018 have lost an average of 33 percent compared to a loss of 2 percent by their traditional IPO counterparts. Compare this with the 50 percent return on the S&P 500 and we can begin to see how incredibly extractive this practice is. When we consider that some SPAC sponsors were making triple-digit returns and the hedge funds that participate in SPAC arbitrage made a
median 16 percent return over this time period, the picture is very clear.

SPACs have been able to entice investors with unbelievable forward-looking projections, a practice that isn’t allowed in traditional IPOs, through a safe harbour provision reserved for mergers. Along with the same mania that fueled excess risk taking in so-called meme stocks, speculative cryptocurrencies, and non-fungible tokens (NFTs), shares of SPACdriven
companies were all the rage in 2020 and 2021. However, as inflation and rising interest rates cool markets, SPACs have fallen out of favour. Regulators have also cracked down, ending the safe-harbour provision hopefully applying the brakes to the predatory practices many SPAC sponsors and company founders use to pad their pockets. Many prominent investment banks have extremely reduced or completely stopped their SPAC activity.

Financial markets have always been a place where innovations have been highly lucrative. There are many times in history where these innovations have been abused and led to extraction of value by those creating overly complex products and offloading them on those who are less aware. At Viewpoint, we believe strongly in transparency and an open-box approach to our processes and models. Alignment has always been a foundational part of our firm and we are keenly focused on investor education. In the ever-changing investment landscape, we seek to demystify the complexity and focus on enduring financial principles augmented with data science to take an evidence-based approach to investing.