Morgan Creek Capital Management recently teamed up with fintech company EXOS Financial to launch the Morgan Creek – Exos Active SPAC Arbitrage ETF (CSH). CSH is an actively managed ETF that invests in SPACs and their underlying U.S. Treasury collateral to earn a potentially higher return per unit of risk than traditional cash alternatives.
Mark Yusko, founder, CEO, and CIO of Morgan Creek Capital Management recently shared his insights on SPAC arbitrage with ETF Trends.
Elle Caruso, ETF Trends: In the current economic climate, dominated by concerns of inflation and rising interest rates, why are SPACs an attractive investment option?
Mark Yusko, founder, CEO, and CIO of Morgan Creek Capital Management: SPACs are a unique investment vehicle that are simply a portfolio of Treasuries that sit in an inviolable trust until such time as the sponsor identifies a private company to merge with and enable the company to come public. In addition, the SPAC unit holders also receive warrants to purchase shares at a fixed price (usually $11.50) in the future.
In a world of financial repression, where central banks have chosen to punish savers by taking cash interest rates near zero, the opportunity to utilize SPAC arbitrage to earn superior returns with similar risk is a smart alternative to cash. By holding the SPACs until a deal is announced (on average 12-18 months) the investor earns roughly 1% to 2% from the underlying collateral of the trust, plus some incremental return from the value of the warrants across a broadly diversified portfolio.
Additionally, it is possible to purchase SPACs below trust value at times and lock in some incremental return. Earning higher returns on cash is even more important in a high inflation regime as the real return for investors is starkly negative. Given the short duration of the collateral in the SPAC trusts, there is very little risk to rising rates and even an ability to reset the collateral with higher-yielding Treasuries over time.
Caruso: How do SPACs compare to other traditional cash alternatives?
Yusko: We believe that a SPAC arbitrage strategy has the potential to significantly exceed the returns of cash and cash equivalents.
Caruso: Can you explain the stages of a SPAC’s life cycle? Your new fund, the Morgan Creek – Exos Active SPAC Arbitrage ETF (CSH), invests in a stage that offers the protection of the U.S. government credit with the upside potential of equity. What does this mean?
Yusko: A SPAC goes public and raises a pool of capital that is placed in a trust and invested in Treasuries, government-backed credit securities. The SPAC then identifies a target private company to enable that company to go public. When the deal is announced, investors can choose to participate in the post-merger combined entity (new stock) or redeem for cash plus accrued interest. The SPAC then de-SPACs 52 days later and goes away; and the new company continues as a public entity. For example, IPOB was the SPAC, and SPCE is the ongoing company, Virgin Galactic.1 The SPAC investor also receives warrants on the post-merger combined entity and those warrants can be held to participate in the equity upside of the ongoing business or can be sold to lock in a profit. The worst-case scenario is you get a Treasury return, and the upside is the possibility that the post-merger combined entity performs very well and you get equity-like returns.
Caruso: My understanding is if you invest in a SPAC at the IPO stage, you are relying on the management team that formed the SPAC to find an acquisition or combine with an operating company. If this is the case, how can an investment team managing an active ETF evaluate opportunities?
Yusko: The best part of SPAC arbitrage is that the core return of the structural arbitrage is not dependent on the quality of the companies selected by the SPAC sponsors for the mergers. We harvest the gains from the trust, and then we have an opportunity to actively decide which companies to support by holding the warrants. We have an opportunity to make that decision with superior information after the deal is announced, and then we can evaluate the pricing of the deal and the fundamentals of the company. We also get to add value by actively acquiring SPAC positions in the markets when the price is below the trust value.
Caruso: I think there’s a lingering fear among investors that as the number of SPACs seeking to acquire operating businesses increases, attractive initial business combinations will become scarcer. How would you address that concern?
Yusko: The concern that there are limited outstanding opportunities is valid, but the core of SPAC arbitrage is not dependent on having lots of home runs in the post-merger combined entity stage. The core returns come from the potential of earning “better than cash returns” from the trust collateral and adding value from active management. The other mitigating factor is that SPACs have become the preferred method for high-growth, innovative companies to go public, and there has been a continual stream of innovation over the decades, and we expect that trend to persist and for those companies to continue to favor SPAC mergers over IPOs.
Caruso: Historically, nearly 20% of SPACs have liquidated — a percentage that does seem to be trending downward rather quickly. How does liquidation affect investors? Do you expect this rate will continue to trend downward, or are there anticipated headwinds?
Yusko: The early days of SPACs saw high liquidation rates because the quality of the sponsors was very low and the barriers to entry were high for high-growth, innovative companies to participate, in terms of profits and forward-looking statements. The rule changes in 2015 put the liquidation trend on a downward path, and there were actually no liquidations in 2020. Liquidations don’t impact the SPAC arbitrage strategy materially because the core return is from the trust collateral (which is earned), and our experience includes some number of deals where the warrant return is not material.
Caruso: What happens to the investment in the SPAC after the merger?
Yusko: The CSH strategy is to liquidate the fund’s SPAC holdings at the deal announcement and does not hold post-merger combined entities.
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More information about Morgan Creek’s CSH ETF can be found at csh-etf.com.
1 For current portfolio holdings please download fund holdings at https://www.csh-etf/ (see “Download Full Fund Holdings”). Portfolio holdings should not be considered investment advice or a recommendation to buy, sell, or hold any particular security. It should not be assumed that an investment in the securities identified was or will be profitable.
Carefully consider the Fund’s investment objectives, risk factors, charges and expenses before investing. This and additional information can be found in the Fund’s prospectus and summary prospectus, which may be obtained visiting the Fund’s website https://www.csh-etf.com or calling (855) 857-2677. Read the prospectus carefully before investing.
Investing involves risk, including the possible loss of principal. Shares of any ETF are bought and sold at market price (not NAV), may trade at a discount or premium to NAV and are not individually redeemed from the Fund. Brokerage commissions will reduce returns. Past performance is no guarantee of future results.
The Fund invests in equity securities, warrants and rights of SPACs, which raise funds to seek potential Combination opportunities. Unless and until a Combination is completed, a SPAC generally invests its assets in U.S. government securities, money market securities, and cash. If a Combination that meets the requirements for the SPAC is not completed within a pre-established period of time (e.g., 18-24 months), the invested funds are generally returned to the entity’s shareholders (less any applicable taxes, fees, and administrative expenses); however, in certain cases, the SPAC may extend its period of operations beyond the initial pre-established period of time. If this occurs, a fund investing in the SPAC may have difficulty redeeming its holdings, or may not be able to do so at a desirable time. Because SPACs have no operating history or ongoing business other than seeking Combinations, the value of their securities is particularly dependent on the ability of the entity’s management to identify and complete a profitable Combination. There is no guarantee that the SPACs in which the Fund invests will complete a Combination or that any Combination that is completed will be profitable.
Borrowing magnifies the potential for gain or loss by the Fund and, therefore, increases the possibility of fluctuation in the Fund’s NAV. This is the speculative factor known as leverage. Because the Fund’s investments will fluctuate in value, while the interest on borrowed amounts may be fixed, the Fund’s NAV may tend to increase more as the value of its investments increases, or to decrease more as the value of its investments decreases, during times of borrowing. Unless profits on investments acquired with borrowed funds exceed the costs of borrowing, the use of borrowing will cause the Fund’s investment performance to decrease.
Post-Combination SPAC Warrants. Although the Fund generally will not hold the common stock of a Post-Combination SPAC, the Fund may hold warrants to buy the stock of companies that are derived from a SPAC. Post-Combination SPACs may be unseasoned and lack a trading history, a track record of reporting to investors, and widely available research coverage. Post-Combination SPACs are thus often subject to extreme price volatility and speculative trading. The stocks underlying the warrants may have above average price appreciation that may not continue and the performance of these stocks may not replicate the performance exhibited in the past, which could adversely affect the value of the warrants the Fund holds.
Because the Fund is “non-diversified,” it may invest a greater percentage of its assets in the securities of a single issuer or a lesser number of issuers than if it was a diversified fund. As a result, a decline in the value of an investment in a single issuer or a small number of issuers could cause the Fund’s overall value to decline to a great degree than if the Fund held a more diversified portfolio. The fund is new and has a limited operating history.
Glossary: “Pre-Combination” SPACs are SPACs that are either seeking a target for Combination or have not yet completed a Combination with an identified target. “Post-Combination” SPACs are operating companies that have completed a Combination with a SPAC within the last three calendar years.
Opinions expressed are subject to change at any time, are not guaranteed and should not be considered investment advice.
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