Leon Mehl

Special Purpose Acquisition Companies (SPACs) have become a popular topic for discussion in the mainstream conversation of finance in recent months. The primary purpose of a SPAC is to make a public offering of a private company. In SPACs, private companies are able to go public without needing to go down the official IPO process. 2021 has already been a blockbuster year for SPAC underwritings due to the hefty valuations that SPACs have received from public demand. However, the present situation could potentially turn into a misallocation of public capital, if existing risk-taking behavior continues to move at its current pace.

Today’s high valuations in public markets have made it an opportune time for companies to go public in a SPAC. Without a SPAC, private companies in a venture are naturally left to find fresh capital in private channels, which could either be in low supply or based on smaller valuations. Yet, even in private equity markets, activity has been on the rise and valuations have been pushed higher. SPACs democratize markets for regular investors who would otherwise be locked out of such investments. It is important to remain mindful of both the potential return and risk.

There have been examples of successful companies going public through a SPAC, such as Virgin Galactic, DraftKings, Lordstown Motors, and Opendoor Technologies. Many of these companies have valuations well into the billions. However, SPACs are high risk since many of these venture companies are in their pre-revenue days, earn no profits, and operate in unproven product markets. These factors make a traditional IPO difficult because when the facts of a venture are made clear, public interest for its IPO can dissolve into a reduced IPO price or even a cancellation of the IPO. Valuations are built on the future and the latest rush into SPACs necessitates a promising tomorrow.

The first quarter of 2021 has seen unprecedented flows move into SPACs. About one-hundred billion dollars have gone into SPACs this year, which already exceeds the combined sums of 2018, 2019, and 2020. Furthermore, about 70% of all new money raised in IPOs this year has been in SPACs.

Today’s rise in SPAC investing could serve as a testimony to the current times. In an effort to make sound decisions, investors need to be mindful of certain key shifts in the investment landscape which relate to the rise in SPAC popularity. SPACs were once popular investments in the lead up to the dot-com bubble. In those days, risk-taking was a popular pursuit since public capital was relatively cheap and plentiful. In the current landscape, we have experienced unprecedented fiscal stimulus during a time when monetary policy is simultaneously almost as aggressively growth-oriented as possible. These types of policies can lead to certain asset bubbles.

Further, the opportunity cost of investing in equities, through vehicles such as bonds, has been currently pushed to a minimum. All of these trends lead to increased interest in risk assets. Investors become almost agnostic of the price they pay to join in on popular investment trends without any answers for the value that they receive in return. This can lead to further behavioral trends where investors want to follow the “heard” and not miss out on opportunities, leading to additional price appreciation. It is important for investors to appropriately balance any investment’s risks and rewards as well as maintain a full perspective of these broader investment trends.

US Stocks experienced another great month and added to their year-to-date gains. US large-caps and mid-caps earned the lead in March on total returns that grew past 4.0%. Small-caps produced a total return that exceeded 3.0%. The first quarter of 2021 has kept the trend for US stock investments well and alive. Year-to-date returns rest at 6.8% for large-caps and 15.1% for small-caps. Mid-cap performance lies somewhere in between.

Foreign Bonds were the largest loss leader this month and for the quarter. The composite average declined nearly -1.4% in March led by the declines of the world bond category. But even the riskier category of emerging markets was unable to offset the losses made in developed bonds this year. Altogether, developed and emerging are in a deficit this year with each sharing approximate performance of about -3.4%.

Foreign Stock returns were boosted in March, but the risk held in foreign has not been as rewarding as it was in domestic investments. Developed and small-caps received respectable one-month returns over 2.0% in the prior month. Emerging markets, however, gave back some gains in March as Chinese stocks were on a retreat. First quarter returns have averaged around 4.0% with small-cap investments doing the best.

Hard Assets were in the green in March across all category averages. Strong demand showed for limited partnerships in energy based on the monthly total return of 6.2%. Their year-to-date currently stands positive at 17.2%. Real estate also experienced fund inflows in March, which raised their year-to-date returns to an average of 6.7%. Precious metals, however, continue to lag on a first quarter loss that has grown to -11.4%.

US Bond brought in some small losses last month. Corporate bonds were the greatest monthly lagger on losses of -1.4%. Their year-to-date loss has grown to almost -3.9% in 2021. The other loss leader this year has been in US treasuries, which are now in possession of a first quarter loss of about -2.1%. Bonds on the riskier spectrum, such as junk bonds and bank loans, have maintained their small gains.

Hybrids had total returns that were mostly flat in March. Preferred stocks were in the spotlight last month on performance that nearly made 2.0%. Convertible bonds lost ground with a loss of -3.2%. Losses in convertibles while stocks maintained their assent was a different event to observe in recent months. Year-to-date, convertibles carry a small lead over preferred stocks, but the two returns are close to 1.5%.