Christopher Raby, BridgeTower Media Newswires
Later this month, the Federal Reserve meets to mull the future of short-term interest rates. If the Fed proceeds as the market expects, short-term rates will trend lower well into 2020. Faced with the prospect of low short-term rates, many investors are anxiously seeking yield opportunities from alternative sources. Special Purpose Acquisition Companies, or SPACs, present such an opportunity.
SPACs - once popular in the early 1990s, only to fade away - have recently re-emerged in the financial markets. SPACs permit the investing public the opportunity to act like a private equity manager and speculate in securities often reserved for institutional investors and private equity firms. Formed during an Initial Public Offering (IPO), a SPAC essentially consists of a blank check written by investors to a management team. That management team then spends the next 18 to 24 months searching for a merger candidate they feel would create an accretive transaction that would benefit investors.
When a SPAC is created, it's created as a 'unit' composed of a combination of common shares, warrants and rights, which are sold to investors for $10 a unit. After the SPAC IPO, the majority of the cash received from investors is placed in an interest-bearing trust account and held in cash and short-term T-bills. The money will be held in trust, protected by a third-party agent, until a business combination is approved by shareholders.
SPAC units trade on an organized stock exchange; providing liquidity for investors of the IPO should they wish to sell their units. After a short period of time, the units split into their individual, tradable components. The common shares, warrants and rights trade individually on the stock exchange. However, only owners of the SPAC common shares retain a claim to the IPO cash placed in the trust account. Because the shares are freely tradeable, SPAC common shares can trade at a discount or premium to its cash trust value. By buying SPAC common shares at a discount to their cash value, investors can earn.
Common shareholders are able to make a claim for their portion of the cash trust during certain events in the SPAC's life - typically either when the SPAC seeks a life extension, seeks to approve a merger with an acquisition target or liquidates due to the end of the SPAC's planned life. During these events, common shareholders are able to request their shares be redeemed for their portion of the trust account.
The total return earned from a SPAC common share investment comes from two sources. First, interest earned on the trust account accumulates during the life of the SPAC - similar to what an investor would own by individually holding short-term cash and T-Bills. Secondly, by purchasing shares at a discount to cash and then closing that discount during an 'event', an additional return is earned. Because of a SPAC's unique structure, they make for a compelling investment for a portion of an investor's short-term portfolio.
-----
Christopher Raby, CFA is a senior taxable fixed income portfolio manager for Karpus Investment Management, a local independent, registered investment advisor managing assets for individuals, corporations, non-profits and trustees. Offices are located at 183 Sully's Trail, Pittsford, NY 14534 (585-586-4680).
Published: Fri, Sep 13, 2019
