“The level of confidence is through the ceiling”

Wall Street has an estimated new investment. And while financiers will reap great benefits, there are reasons for popular investors to tread lightly.

Investments (SPAC, or special purpose acquisition companies) are like quasi-IPOs:

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

More information on personal finance:
The fiscal season has begun. Many are still looking for a $ 600 stimulus
Biden expands protections for homeowners
A large number of unemployment claims are due to repeated pandemic layoffs

SPAC advocates see them as a form of venture capital that can allow investors to get a piece of high-growth companies at an early stage. There is also some protection against losses, 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. Administrators can identify specific industry or business targets in initial applications, but are not required to pursue them, essentially giving them carte blanche.

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

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

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

“Right now, we’re putting it on [SPACs] in a bucket with gold and bitcoin, “he added.” It is highly speculative. And there is no financial analysis that can really do that. “

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

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

Last month they raised nearly $ 26 billion, a record.

“The market is exploding,” Ritter said.

Retail investors seem to be driving much of the frenzy, as they did with other recent obsessions like GameStop shares.

But the video game retailer offers a cautionary tale for investors trying to capitalize on a hot-ticket item: shares rose 1,700% in less than a month; it quickly lost most (85%) of its value in the next two weeks.

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

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

“If things hadn’t gone so well in the last six months, I don’t think we would have seen this boom, ”he said.

There are reasons for caution, according to financial experts.

Increasingly, popular investors are not buying shares at the initial listing price of SPACs, Ritter said. (They typically trade at $ 10 per share.) Retail investors who don’t come in early won’t participate as much (or not at all) in this initial stock price saving.

One of the key selling points of the SPACs has been the guarantee of a refund, which limits the risk downwards. Investors may choose to change their shares when a merger or acquisition is announced, rather than becoming shareholders of the combined entity.

However, investors will not necessarily get it back. They are entitled to $ 10 per share plus some interest. If they bought stocks at a higher price on the open market (for example, for $ 12), they would have losses (about $ 2 per share, in this example). Shares of the combined entity may also fall below $ 10 when it begins trading.

“As with anything else, 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 all situations.”

Yields have also not been stellar when measured compared to standard benchmarks, according to experts.

Michael Cembalest wrote in a recent note from JPMorgan analyst, that the typical SPAC buy and hold investor got a 45% gross return between January 2019 and 2021. (The analysis measures the returns of the average investor.)

However, investors would have obtained a higher return on the S&P 500 stock index, which gained 52% in the same period of time.

“Absolute good returns so far, but in the stock markets, the rising tide is lifting all the ships,” said Cembalest, chairman of JP Morgan Asset Management’s market and investment strategy, suggesting that SPAC they are recovering a strong stock market.

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

This is partly due to the structure of the funds: managers usually obtain a 20% stake in the acquired company at a reduced initial cost. They get nothing if no agreement is reached.

Therefore, they have an incentive to make deals. Bonds can be harder to get in a flooded capital market for investors.

“The SPAC boom may end up bringing many previous and much riskier companies to market,” according to Cembalest.