As I have been going through hedge fund 13F reports over the past few days, I've noticed one clear trend. Most big-name firms have built up extensive holdings of Special Purpose Acquisition Companies (SPAC) in 2021.
Seth Klarman (Trades, Portfolio)'s Baupost is a great example. According to the hedge fund's 13F for the three months ended March 2021, Baupost owned the following SPACs:
- Reinvent Technology Partners Y Units (RTPYU, Financial)
- Avanti Acquisition Corp. (AVAN, Financial)
- Reinvent Technology Partners (RTP, Financial)
- Horizon Acquisition Corp. II (HZON, Financial)
- Liberty Media Acquisition Corp. (LMACA, Financial)
- Broadstone Acquisition Corp. (BSN, Financial)
- Altimeter Growth Corp. 2 (AGCB, Financial)
- Investindustrial Acquisition Corp. (IIAC, Financial)
- Dragoneer Growth Opportunities Corp. III (DGNU, Financial)
- Finch Therapeutics Group Inc. (FNCH, Financial)
- SVF Investment Corp. (SVFA)
- Dragoneer Growth Opportunities Corp. II (DGNS)
- Reinvent Technology Partners Z (RTPZ)
The hedge fund also owned warrants in many of the companies listed above. None of the positions were massive. I would estimate that all of Baupost's SPAC holdings account for less than 1% of total assets under management.
So, when compared to the largest equity position in Baupost's portfolio, Intel (INTC), which accounted for around 5% of assets at the end of March, it's clear that Klarman is keeping his options open with these positions.
Klarman isn't the only manager buying SPACs in volume. David Tepper (Trades, Portfolio)'s Appaloosa Management, Lee Ainslie (Trades, Portfolio)'s Maverick Capital, Daniel Loeb (Trades, Portfolio)'s Third Point, David Einhorn (Trades, Portfolio)'s Greenlight Capital and Chase Coleman (Trades, Portfolio)'s Tiger Global Management all bought shares in Altimeter Growth Corp. 2 during the first quarter. That's just one of the companies these managers were buying.
This brings the question: why are all these big-name firms suddenly so interested in an asset class that has historically been unreliable at best?
Risk-free profit
The short answer is that these firms have been acquiring SPACs because they can provide an opportunity to generate almost risk-free (for them) profit with little to no downside.
SPACs are relatively unique investment vehicles. They are blank shell companies with no operations of their own, which intend to make an acquisition using shareholder funds. When they go public, units are issued at a price usually set at $10. These units sold to the public also typically offer a fraction of a warrant, which gives investors the opportunity to purchase a whole share of common stock at a discounted value.
When a SPAC has raised its money, the cash is then deposited in a trust account invested in Treasuries until such time as the company can find an attractive acquisition.
If the company does not find an acquisition within a set time frame, it has to return the money held in the trust to investors. Other trigger events may also trigger the return of capital.
In this sense, SPACs are a lot like zero-coupon bonds. If a firm is able to acquire SPAC units at a discount to the offer price, it could earn a risk-free return if there's no merger. And if there is a merger, the potential for reward is significantly higher.
Higher returns
Saba Capital compiled a list of attractive SPAC acquisitions towards the end of 2020.
The portfolio of 20 different companies it highlighted offered a yield to maturity of 2.3% based on a below trust acquisition price. The yield to maturity was based on the timeframe available to the trust to find a potential acquisition as displayed in its offering documents. That assumed the SPAC never merged with another company and returned its cash to investors.
At the end of 2020, the yield on the 10-year Treasury was around 0.92%. This goes some way to explaining why hedge funds have been piling into SPACs. These companies offered a risk-free return of 2.3% at the end of 2020, compared to 0.92% for the the benchmark 10-year.
What's more, the U.S. government security does not offer the potential of further upside in the event of an acquisition. From this perspective, SPACs are the perfect investments for hedge funds seeking reduced risk and high returns.
Disclosure: The author owns no share mentioned.
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