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SPACs, or special purpose acquisition companies, are non-operating publicly traded companies created to acquire or merge with existing companies. While SPACs have been around for decades, their popularity has surged in recent years, leading to misconceptions about the structure and oversimplification of the risks and rewards associated.
Recently, ETF Trends’ managing editor Lara Crigger sat down with Jonathan Browne, portfolio manager and director of research at Robinson Capital, to discuss how SPACs can be used as alternative fixed-income investments and why Browne favors pre-merger SPACs for their attractive risk/reward profiles.
Robinson Capital specializes in alternative fixed income strategies, providing solutions that offer higher yield without taking on added risk to advisors who realize their fixed income portfolios are not providing the income or safety that they once did.
Lara Crigger, managing editor, ETF Trends and ETF Database: You’re an alternative fixed income shop investing in SPACs. How did you get involved in that?
Jonathan Browne, portfolio manager and director of research, Robinson Capital: We’ve historically been investing in closed-end funds and taking advantage of the irrational discounts that they provide. But, as fixed-income managers, our goal is always to protect our clients’ principles. What’s unique about [pre-merger SPACs] is that they provide absolute downside protection. Pre-merger SPACs are those that haven’t completed a merger yet; all they are is a pool of capital that’s raised by a sponsor or management team to ultimately go out and find a private company to bring public.
What’s unique is that all of the money or proceeds they raise via prospectus have to be placed in a trust account or an escrow account invested in T-bills. At the end of the day, whether that sponsor manager finds a deal or not, the end investor can redeem their shares for trust value, which we’ll call $10 a share.
We know that whether a deal is found or not if we can buy these — and right now, we can buy these around three, three and a half percent below that $10 trust value — we know that no matter what happens, that at the end of the SPAC’s life cycle, which is generally 12 to 24 months, we can get $10 back.
So we have that absolute downside protection of pre-merger SPACs. If the market drops 50%, I know that no matter what, I can redeem these SPACs for trust value or positive 3.5% return. What other investment have you ever seen where you know that your worst case is a positive return?
Crigger: Well, there’s bonds, right?
Browne: Pre-merger SPACs are really just a bond, right? At the end of the day, it has a stated maturity, just like a bond. It has the credit interest rate risk of a T-bill portfolio because all of that cash is just sitting in a trust account that’s invested in six month tables or less, so you don’t have the credit and interest rate risk of a corporate bond.
What really gets us excited is you have equity-like upside optionality — if any of the SPACs that we own announce a merger target that the market finds interesting… You just don’t have that upside potential in traditional bonds.
Crigger: For a financial advisor who’s looking at this, hearing the argument that you can think of these investments as a fixed income investment — it seems then implementing it and executing on the strategy, you would be pulling from your other fixed income allocation and replacing it with something like this.
Browne: Absolutely. What’s also somewhat unique is that it’s pretty versatile. We’re approaching it as an alternative fixed income because we think it’s an absolute no-brainer, especially if you’re worried about credit or interest rate risks…But we also realize that there are advisors out there who may have an alternative sleeve that they have absolute return strategies or M&A-type strategies in there, and this fits the bill perfectly. I can even make the case that for someone concerned about equities, this is a much better defensive equity holding, just given that absolute downside exists.
Crigger: When you’re thinking about the risks inherent in your strategy, what are some of the risks that folks need to keep in mind?
Browne: Going back to the pre-merger, the risks are extremely limited. Until they complete a merger, [pre-merger SPACs are] just a pool of cash that’s sitting there waiting to be deployed. And so they’re all sitting in six-month T-bills, or less. And that’s written in every single prospectus of the SPACs that they must be invested in T-bills. So your risk is equivalent to a T-bill portfolio.
Once you get past the pre-merger SPAC into when they post-merger SPAC or de-SPAC and become equities, you have 100% downside potential just like every other equity that’s out there. It also means you have the volatility of small-cap equities.
For more news, information, and strategy, visit the Alternatives Channel.
