3 market experts take us inside SPAC arbitrage, the 'simple but not easy' strategy that investors are banking on to print money amid the blank-check downturn
- A total of 228 SPACs had raised $73.2 billion as of March 8, according to SPAC Research.
- The boom has made the “SPAC arbitrage” strategy challenging to execute in the past few months.
- Three experts break down how ongoing SPAC sell-offs could change the game.
- Visit the Business section of Insider for more stories.
There’s been a broad sell-off in SPAC names over the past two weeks, as the so-called blank-check boom deflates.
For some SPAC investors, it’s a welcome change.
Julian Klymochko, who runs the active SPAC-focused Accelerate Arbitrage Fund (ARB), said he was “very happy” to see the correction.
The Canadian investor employs what he calls a “simple but not easy” SPAC arbitrage strategy, which distills down to buying a SPAC at or below its net asset value (or trust value) and capitalizing on the option of redeeming shares in two years or less.
The strategy fared well amid the SPAC boom last year and was up about 30%, Klymochko told Insider.
This year, despite a record 228 SPACs having raised $73.2 billion as of March 8, Klymochko was left starving for opportunities.
“I was depressed in January and February because there weren’t a lot of opportunities, so we were actually selling quite a bit back then,” Klymochko said. “But now we’re putting serious money to work, which is phenomenal to see. We’ve been buying aggressively millions and millions of dollars of SPACs.”
The state of SPAC arbitrage
The key to Klymochko’s conundrum lies in how SPAC arbitrage works.
SPACs are structured as units, typically priced at $10 apiece. Each unit is comprised of a redeemable share and a detachable warrant, the latter of which allows investors to buy more shares in the future at a premium to the issue price.
“Once a SPAC announces a merger target, investors have the ability to redeem their shares for cash, but they can keep their warrants for free — this makes SPACs particularly appealing for arbitrageurs,” Bank of America analyst Michael Carrier wrote in a February 19 research note.
However, the arbitrage opportunity only exists when investors are paying at or below trust value for their SPAC units. According to JPMorgan, over 80% of SPACs were trading above their trust value as of January. The dynamic is illustrated in the chart below.
“If trust value is $10 and you buy it at $10, then you’re in a pretty good spot,” David Lebovitz, global market strategist at JPMorgan’s $2.2 trillion asset management arm, said in an interview. “The problem is if the trust value is $10 and you buy it at $15, and you go to redeem your shares, you’re only going to get $10 back.”
Lebovitz believes that investor enthusiasm and risk-on sentiment, along with a market flush with liquidity, has created such an exuberance around SPACs that they have unintentionally undermined the unique attributes that made SPACs attractive in the first place.
Switching courses amid the SPAC craze
As retail investors, hedge funds, and institutional investors all jumped in and bid up SPAC prices, arbitrageurs had to switch gears and briefly shift their strategy.
Klymochko said he had to fight for SPAC IPO allocations because the first-day pops were generating “insane” returns right out of the gate.
“We were stuck fighting for IPO allocations because then we were buying at $10 and those would instantly trade up 5% to 10%,” he said of his brief strategy change. “Some of them would trade it up instantly 30%, which is just insane, so we got very competitive.”
Evan Ratner, SPAC portfolio manager at Easterly Investment Partners, believes that the arbitrage strategy has almost faded away due to the excess of SPACs in the market.
“It used to be you would buy the units at $10, they would trade to a slight premium or stay at $10. Then you would separate the unit into the warrant and the common share, and the common would trade to $9.80 or $9.75,” he said. “But there would be $10.20 in trusts, you could make 40 or 50 cents if you redeem.”
But today, with so many SPACs trading at premiums, the alpha has been chased out and the returns have become more normalized, Ratner said, adding that he is taking a value-oriented approach to selecting SPACs and investing in undervalued companies that are mispriced because they went public via SPACs.
New arbitrage opportunities after the sell-off
For Klymochko, the market volatility over the past two weeks has unlocked plenty of new opportunities.
For example, Churchill Capital Corp. (CCIV) and Social Capital Hedosophia Holdings Corp. (IPOD) are among the high-profile SPACs that have slumped in recent weeks, and the IPOX SPAC index is in a bear market, down more than 20% from its February high.
Klymochko, who says he’s invested in over 200 SPACs, teased on Twitter that he has been buying SPACs like “a kid in the candy store.”
But that still doesn’t mean it’s easy work, he continues to get up at 4:30 am every morning to run his SPAC arbitrage fund while maintaining a demanding schedule promoting his SPAC insights.
“It is simple in that we buy SPACs at a discount and sell them at a premium. Buy low, sell high — that’s simple,” he said. “But it’s incredibly difficult to execute. I see people get screwed up and lose their shirt all the time.”
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