Editor’s Note: This article is part of Joanna Makris’s Behind the Wall series, where she provides retail investors with the insider scoop on the hottest technologies and trends from today’s business leaders, industry experts and money managers.
Our latest Fireside Chat offers a fund manager’s view on how to invest in special purpose acquisition companies (SPACs). I had a lively conversation with David Sherman, Founder and Portfolio Manager of SEC-registered investment adviser CrossingBridge Advisors. Based in Pleasantville, New York, with $2.8 billion in assets under management (AUM), the firm specializes in ultra-short duration, low-duration high-yield and responsible credit strategies in addition to SPACs. Earlier this month, the firm also launched its CrossingBridge Pre-Merger SPAC ETF (NASDAQ:SPC).
This isn’t the first or only SPAC ETF. But it is different. And for anyone trading SPACs or fast-money tech, Sherman has his eye on some predictable market movements that are worth your attention.
Here’s why Sherman’s investment strategy got my attention: he’s using a combination of old-school fundamental analysis and new-school market psychology. As a fundamentals-based investor, numbers matter. But it’s when you can combine valuation sensitivity with momentum-based trading that the magic happens.
So just what is that strategy? CrossingBridge only invests in pre-merger SPACs at or below par value. Additionally, the fund will only hold shares for up to 10 days post-merger. It doesn’t plan to stick around and be an equity investor in the SPAC following the initial public offering (IPO). As Sherman has made clear, “SPC is a renter, not an owner.”
In a volatile market, Sherman’s defensive strategy may be a good tool for your belt. And even for an investor who did very well in SPACs last year, 2021 has been a mixed bag. It can sometimes seem a lot like a “random walk,” as the fund manager puts it.
My take: the market is great at creating SPAC unicorns but poor at taking them public. Case in point? The two funds that partially track post-SPAC companies have both posted negative returns this year.
The Morgan Creek Capital Management Exos SPAC Originated ETF (NYSEARCA:SPXZ) has declined 36% year-to-date (YTD). Likewise, the Defiance Next Gen SPAC Derived ETF (NYSEARCA:SPAK) is down 22% YTD. By contrast, the S&P 500 is up about 17% over the same period.
With all that in mind, read on to hear Sherman’s fresh take on SPAC investing. The fund manager shares the details of his asset-based, defensive strategy and how investors can use his strategy to lock in gains. In a market where growth stocks are getting slammed by rotational correction, Sherman’s timing is just about perfect. And if you’re chuckling in amusement as all the talking heads debate the great “taper tantrum,” Sherman offers this advice: fund managers should say “I don’t know” more often.
I know you’re excited about the launch of your new Crossing Bridge SPAC ETF… There are other SPAC ETFs in the space and others that do focus on pre-merger SPACs. But what you’re doing is clearly very different. So talk to us about that.
David Sherman: So the ETF that we launched last week is the CrossingBridge Pre-Merger SPAC under the symbol “SPC.” I jokingly say, “It’s SPAC without vowels.” And this ETF is very, very focused on taking the discount between the trust value of a SPAC that’s sitting in treasuries and the current market price, and capturing that discount as a short-term alternative, almost like a fixed income-like security.
As your listeners know, SPACs, when they get issued, put money into a collateral trust. That trust is for the benefit of the shareholders. And then the shareholders get that back if there’s a liquidation, or if they merge with another company. The shareholder has the right to either merge into the deal and participate in the future equity […] or they can choose to redeem their interest, not participate and get their pro rata share — that collateral trust.
So a typical SPAC is issued at $10. Maybe today, it’s trading at $9.70. I’m excluding the warrants. That’s a 30 cent discount over $9.70. And that spread — that 30 cents — we’re going to capture between now and liquidation, or until now and when they redeem.
So what makes this ETF different, as we in our prospectus say, [is] we will never purchase a SPAC unless it’s at or below trust value… We’re not speculating on the equity merger of the company. We are specifically buying it at or below trust value, so it has principle backing behind it. So if you hold this portfolio, ignoring mark-to-markets, we should not lose money.
And then on top of [that], we plan to dispose of these securities no later than 10 business days post merger, which means the reality is we plan to redeem. We don’t plan to hang around and see the transaction.
Now tell us why: what does that mean for how you view the post-merger SPAC market?
So our firm as a whole — our $2.8 billion firm — is active in the stock market across our funds and various components. We’re involved in sponsor shares. We’re involved in IPO shares, which this ETF can participate in. We’re involved in the secondary market, which this fund can participate in. We’re even involved in anchoring and being involved in PIPEs and redemptions, backstops. And we also participate — obviously, because you’re involved in a PIPE — in the post-merger deal.
However, this fund is not doing post-mergers. And the reason is, that’s an equity evaluation. You’re trying to figure out “what will this company be worth in the future?” and “am I paying the correct price for it today?” Whereas we don’t need to make that assessment.
We are looking at it as a fixed-income security, which is [if] there’s a maturity, we’re going to get our money back. And if someone else wants to participate in the equity future upside, they can do that. That’s just not what this fund does.
This fund is an alternative for [when] you have a bunch of cash sitting around or you have a short-term bond portfolio. And in today’s market, you can make three percent or more, most likely more, just buying a bunch of SPACs trading [at] a discount to the liquidation date. And if the liquidation date doesn’t happen because the company announces a deal sooner, you’ll make a higher return. Because your discount will amortize over a short period of time, you’ll earn it out sooner.
When I say three percent, I don’t mean gross. I mean compounded annually… like a yield to maturity. [And] there’s very few places where you can get capital gains tax treatment and earn three percent on cash balances that you plan to hold for six months to two years.
So talk to us about what the pre-merger SPAC landscape looks like? How many companies are truly trading at a discount and what other metrics do you look at? Aside from the discounted valuation, is there anything else that you’re looking at when you choose [a SPAC]?
So let me start with the part about the discounted valuation… Anyone can calculate the yield-to-liquidation. All the data is public. In fact, they can go to spacinformer.com. They can sign up and download the entire SPAC U.S.-traded universe and it’ll come every week. It’ll calculate those gross yields and the yield-to-liquidation. And with their commission-free accounts, they can just go buy a portfolio and do it themselves. They don’t have to buy the ETF.
But you also get the opportunity to make more money if you’re good at being an active manager in determining which SPACs are going to most likely announce a decent deal or a deal that happens sooner. Right? Because if you buy [a pre-merger SPAC] at $9.70 and they announce the deal in 30 days and it trades up to $9.90, you just made 20 cents on a $9.70 basis in a month, which is a very good IRR.
And then you can decide: do you want to participate? Because as people become familiar with that transaction, maybe it trades up. We’re seeing currently in the market that actually, some of the SPACs are starting to trade above their collateral value post-announcement. The Gores Guggenheim (NASDAQ:GGPI) SPAC today just announced a deal that’s trading through trust value because people like it.
So the nice thing about our strategy is that you can also get that potential equity pop that happens every so often to enhance your return. Now [the reason] that retail investors kind of jump into a lot of these names [is] merger speculation. And you see those kinds of movements.
I think active management helps you assess management of SPAC[s] and to help determine which ones might announce good deals or not-as-good deals. And also I think, having a view of where there’s more likely to be better opportunities.
So there’s a ton of fintech SPACs. I don’t think that many fintech potential targets are that good. So figuring out the focus. But at the end of the day, I’d like to tell you we add a lot of value there. And hopefully we do. But the reality is, it might be a random walk.
You know, there are SPACs such as the Pritzker family [Thimble Point Acquisition (NASDAQ:THMA)] which built an industrial empire from nothing to very successful. You would think they would announce a great transaction in their first SPAC. And quite frankly, the market was disappointed, right? So there’s active management where you get to know a situation [and] you think they’re going to do a successful one. And it just turns out to be like every other mediocre SPAC. So it’s more of a random walk.
And I didn’t answer your question. But to give you an idea, as of Friday [Sept. 24], there were $56 billion of SPACs that had a yield liquidation date between two and two-and-a-half percent. Now, there were $6.4 billion that had to yield-to-liquidation of two-and-a-half to three. There were over $3 billion that had a yield in excess of three percent.
All of these have an average life of between 14 and 17 months. And that’s before them announcing a deal sooner where you’ll get a pop, right? [Whether] because your amortization shrunk… or because it’s a good deal.
So the universe is quite big. And it’s become very institutionalized, which [was] not the case when I first invested in SPACs in 2005. This is not a new thing for us.
So you’re looking at all of these names very actively. Are there certain sectors that you think are more interesting? Where do you see a lot of the activity? And where’s your investing focus from an industry vertical perspective right now?
So I think, quite frankly, we’re much more quantitative in screening for what we want to look for, based on length of time [and whether] they have a deal announced or not. And the management team.
So I think those are really overriding factors. Because again, I do think a lot of this is a random walk. And many people say, “Oh, we’re going to be able to pick the best,” [but] you don’t know the deal until they’ve announced the deal.
In fact, often when we do an IPO, we sell off the warrants, because a lot of times people get excited about the management team. And I think they pay a lot for the warrants, because it has a lot of leverage in it.
But until you know the deal, there’s no way of assessing what the value of that warrant’s going to be worth. And as you know, those warrants are worthless if there’s no deal.
So it allows us to reduce our cost basis in the underlying SPAC stock. The other thing is, because we’re such a large player in the IPOs, that this ETF will participate just like our other accounts in the IPOs. So if we happen to anchor a deal — and today they’re giving founder shares away in some cases, when you anchor a deal, for free — the SPAC will be entitled. And this ETF will also be entitled to participate in those founder shares.
So you’ve talked about this [investment] window, you’re not holding [post-merger shares] past 10 days. And then if you look at some of the SPAC ETFs that track post-merger SPACs, they’re significantly underperforming the market. What does that say about the nature of post-merger SPACs?
We participate in post-merger SPACs through PIPEs as a firm. Again, this ETF will not do that. This ETF intends to redeem. It does not participate in PIPEs. But our firm as a whole manages a SPAC book of, [at] any given time of, $250 [million] to $400 million across the board, under different strategies with different funds…
The stock market hasn’t changed a lot since 2005, except that it’s become institutionalized. And there’s a lot more available product to be able to do standalone strategies. As far as the deals themselves, there’s plenty of bad deals [but] most of them aren’t really bad, they’re just overvalued.
There’s also a big dislocation. Remember, most SPACs are basically mid caps. They’re small- and mid-cap companies. There’s not a huge audience for small- and mid-cap companies. There’s very few ETFs or passive investment strategies that capture those companies. So they don’t get the benefit from that. And there’s just not as large an audience. In many cases, a lot of them will become great value opportunities for those value investors who think value investing might be dead. This is a good place to go look for some potential opportunities.
And of course, there’s some bad deals, right? The SPAC market today is divided, I think, really into two types of camps. There’s what I call venture capital financing. And then there’s the growth capital or arithmetic deal business.
So in the arithmetic deal business, you know, these are companies — Foley [Foley Trasimene Acquisition II] just did one, Cerberus [Cerberus Telecom Acquisition] just did one — where they’re SPACs that are buying companies. They’re adding some growth capital, but they’re also using the cash to deleverage… And you can see the cash flows. They have revenue, they have EBITDA, they have a predictable stream.
And then there’s more the venture side, which are venture capital companies looking for a new raise of capital to grow their business. And everyone talks about multiple-to-sales in five years. Right? Okay, if you’re a good venture capital investor, it’s for you. But if you don’t know how to assess that, it’s different and those have a higher degree. So in the electrical vehicle space, you’re seeing a lot of “it went up a lot, it came down a lot,” sort of like the meme stock market.
And, you know, those are what I would call sentiment or behavioral investing. Because they’re believing in an industry or specific company. And there’s no easy way to assess value. It’s like Amazon (NASDAQ:AMZN) in the early days or Tesla (NASDAQ:TSLA) in the early days. There were lots of naysayers, right? Because they said, “Oh, there’s no revenue” or “There’s no profit and they keep losing money.”
… If people believed enough and understood the business model, [then] they work. But there’s plenty of failures. And there’s way more failures than there are successes. We all know the successes. We don’t talk about the failures. But I think that’s what’s interesting about the stock market. From an investor’s perspective, there’s a little bit for everybody.
It’s very hard for retail investors to get a hold of those fundamental trends that really move post-merger SPACs. You’ve got to be a real technologist. You have to really understand the space. I think that’s difficult. And that might account for these fluctuations in the stocks.
I’m not sure even the experts are experts… I believe that most of us just don’t know. And that we’re asked as experts to opine on things when the correct answer is “I don’t know.” I get asked all the time, what are my views on interest rates? I’m like, “I don’t know if they’re going up or down.”
I have a view, but I have no idea. And that’s a hard thing for a financial pundit or money manager to say: “I don’t know.” And I think it’s really key.
So I think the retail investor in some cases may be just as educated and just as good as those that are experts, because they engage. They now have forums such as Reddit, where they can share their ideas. Obviously, there’s some wild comments. But with things like Seeking Alpha and Value Investors Club, Reddit — there are some very well-thought-out views.
On top of it, one of the issues in the SPAC market, which has gotten a lot of magnification from a regulatory purpose — [which], this is for post-deals again, things that [our] pre-merger SPAC is not going to participate in because they’re going to redeem.
But post-merger… a lot of companies can prepare both comparative analysis of who they are and how they compare to their peers from a valuation standpoint, as well as provide forecasts and projections. And I really think that’s where a lot of issues have come up, really in the forecast. And because I think a lot of people tend to be more optimistic, if you’re an equity investor.
I’m a bond investor. We’re skeptics… We go around saying, “We don’t care how big you grow, as long as you give us our money back.” So by nature, we just want to know how you’re going to fail. Right? Whereas growth investors like how well you can do… I think the retail investor has gotten hurt because they bought into forecasts without necessarily being enough of a skeptic.
So you talked about potential for legal regulatory changes with SPACs. Isn’t there some way that potentially some of the changes could affect the SPACs pre-merger? [For example] they might have more restrictions on how they handle their cash, they might not be able to invest it. Or potentially, if it affects the kinds of mergers they could be able to make? PSTH tried to make an investment in a stake of UMG instead of buying a company outright. If there were any changes that affected the pre-merger landscape, how might that affect the way you look at these stocks?
So look, any changes to happen I think will be a benefit for the overall community. I think it’s an interesting product where there’s a real demand and need. And I think there’s lots of institutional players who would like to see the stock market succeed. It’s a great alternative to private equity, right?
So instead of creating a private equity fund — that only super wealthy people and institutions such as pensions and endowments can participate in — this is a way of creating a fun structure, allowing people to participate in potential private equity or venture capital and a more public forum. And there’s a lot of players also.
I think the industry is here to stay — we’ll see. And one of the reasons we launched the ETF SPC is because we think there’s enough institutional liquidity and size to justify a standalone strategy. So I’m in favor of anything that will enhance the product to remain mainstream. And in fact, [compared to] the old days, SPACs have evolved a lot.
Back in 2005, for instance, there was a period where if you voted to redeem your shares to get your cash back because you didn’t want the merger, you had to vote down the deal. Well, that means that sponsors didn’t want to put up capital because most people wanted to redeem. And therefore the deal never happened and went to liquidation.
They separated that. So now you can vote for a deal, get the deal over with, but still get your money back. When you talk about investment restrictions, they’re pretty restricted. I mean, government bonds is a pretty restricted view. And in a low-interest-rate environment, I do think there’s some issues.
So one of the things people don’t talk about is your collateral trust. Typically, all of that benefit goes to the shareholder — not the warrant holder, the shareholder. And typically, your collateral should be more or the same, from the beginning than the end. But if they’re investing in basically instruments that have no yield and they pay Delaware business franchise taxes — which they’re allowed to take out of the trust — you can end up with 9.99 or 9.995 instead of 10.
So you do have to do a little work and figure out and read the documents and see what they can exclude. [But] I don’t think that’s really the issue. I think the issue is, how do you create regulation so that it’s a level playing field so that people feel like they’re getting the same type of treatment they would in a traditional IPO?
Final thoughts? What’s your advice to retail investors looking at the SPAC space? I’m hearing “look for discounted valuations.” Give us your guidance on what to do in this space.
So obviously, we think on a risk-adjusted basis, what we’re doing in the ETF — where you’re buying things at a discount [to] the collateral value — you can assess whether you want to roll into the deal or not. In this case, we’re not going to, but the individual investor could assess, “Is this a good outcome?”
We think the space is offering good downside protection actually, we think you make money if you hold on to it. By definition, if you buy something below — you can buy a Treasury [bond] at the discount [price] and [if] you hold it to maturity, you’re going to make money, right? You’re going to make more [with SPC] than a Treasury [bond]. So I think that’s great.
I think there are different investment strategies for different investment people. It’s a longer conversation. But for instance, if you want to have a portfolio of venture capital, we don’t do this. It’s not something I advocate. It’s not something I’m comfortable with. But there are people that will buy a whole portfolio of warrants under the theory that they built a big venture capital portfolio and it’s diversified. So I think there’s a lot of things. It’s a much longer conversation.
I just think in today’s market, where more than half the SPAC market is yielding easily over 2.5%, or liquidation to 2.5% or more, you can pick up the best short-term rates out there, backed by [Treasury bonds] with a call option on equities.
Your comments and feedback are always welcome. Let’s continue the discussion. Email me at firstname.lastname@example.org.
On the date of publication, Joanna Makris did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Joanna Makris is a Market Analyst at InvestorPlace.com. A strategic thinker and fundamental public equity investor, Joanna leverages over 20 years of experience on Wall Street covering various segments of the Technology, Media, and Telecom sectors at several global investment banks, including Mizuho Securities and Canaccord Genuity.
Click here to follow her Fireside Chats, where she provides retail investors with the scoop on the hottest technologies and trends from today’s business leaders, industry experts and money managers.
Click here to track her top trades, where she sheds light on market psychology and momentum, while leveraging her deep knowledge of fundamental analysis to deliver event-driven trading strategies.