Discounted cash is king in 2018

Major asset classes largely posted negative returns in 2018, save for one, oft forgotten asset class: cash. The S&P US T-Bill 0-3 Month Index posted returns of approximately 1.8% in 2018 (Source: Bloomberg), outpacing broad equity and bond indices. However, "Discounted Cash" far outpaced traditional T-bills in 2018 and is poised to do well into 2019. Special Purpose Acquisition Companies (SPACs) provide just the opportunity to purchase cash at significant discounts.

SPACs, which were once popular in the early 1990s, have seen a recent reemergence 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 that they feel would create an accretive transaction that would benefit investors.

SPAC IPOs are typically a package deal, with IPO investors getting a unit consisting of one common share and one warrant. The warrant gives the investor the right - but not the obligation - to purchase additional shares of common stock at a specific price at some point in the future. During a 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 until a business combination is approved by shareholders.

After the IPO, the 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 and both the common and warrants trade individually on the stock exchange. Similar to closed-end funds, a SPAC shares can trade at a discount or premium to their cash trust value.

SPACs offer both advantages and disadvantages to investors. The first advantage to investing in a SPAC is the ability to participate in a private equity-like transaction. Much like private equity firms, SPAC investors are able to speculate that savvy managers can successfully take private companies public. Additionally, by issuing and trading both common stock and warrants, individual investors are able to custom tailor the risk/return profile of the investment.

SPAC investors also hold considerable power with the voting privileges attached to the common shares. If an investor does not like an acquisition proposed by management, the investor has the ability to redeem their shares for their pro-rata portion of the cash held in the investment trust. Additionally, if a significant amount of shareholders vote against the proposed transaction, the SPAC is liquidated and the trust cash is distributed to all shareholders. The majority of an investor's initial investment - plus interest accrued, less operational expenses - will be returned if the deal is deemed not favorable by the holders of the SPAC's voting common shares. This gives a SPAC investor a limited downside with a potentially unlimited upside.

SPACs also offer a fair amount of uncertainty at IPO. Many SPACs typically do have a target industry in mind, but charters often allow for investment anywhere an accretive acquisition can be found. Also, since SPAC charters can range from 18-24 months with a proposed acquisition occurring at any point during that time period, there is additional uncertainty with the length of investment at IPO.

The ability to redeem shares for cash in trust provides limited downside while the prospect of management finding a strong acquisition candidate provides potentially unlimited upside. With an interesting risk/return profile, SPACs provide a unique and compelling investment for a portion of an investor's 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: Mon, Feb 18, 2019


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