February 25, 2022 – In the current highly volatile geopolitical environment, some investors are beginning to transition from a return on capital risk-taking mindset to a return of capital fear-based mode.
A double-digit equity market drawdown has a way of focusing investors’ collective minds.
The phrase “downside protection” has once again become top of mind for market participants.
With fear ruling the roost and the VIX north of 30, investors are experiencing the urge for a flight-to-safety trade.
Source: CNN
The default flight-to-safety path is to buy U.S. Treasury Bills, the safest asset on the planet.
Treasurys are safe and all, however, present one major hurdle for investors – their yields are meager. 26-week T-Bills currently yield 0.65%.
If investors want the downside protection provided by T-Bills, via certainty of capital return without the credit risk, there is a way to generate significantly higher yields.
Through SPACs, investors can own short-term T-Bills (180-day tenor or less) at a discount as a pathway to generate significantly higher returns without taking much more risk.
Remember, all a SPAC entails is holding U.S. T-Bills in trust, which are redeemable for their cash value within a two-year limit. The average SPAC matures in approximately 10 months.
Currently, the key factor in gaining T-Bill exposure through SPACs is that the yields are multiples higher by owning T-Bills via blank check companies.
In fact, the average SPAC trades at 98 cents on the dollar and sports a yield to maturity of 3.4%, which is not only significantly higher than the 0.65% offered through owning T-Bills outright, but significantly higher than the bond index. Furthermore, SPACs yield equivalent to the 3.4% offered by BBB-corporate bonds with significantly lower duration and without the associated credit risk.
Source: Accelerate
Here is the direct comparison: The SPAC Index yields 3.4% with a duration of 0.9 years, while the bond index yields 2.6% with a duration of 7.3 years.
For 800 bps less yield, you are taking 6.4 more years of interest rate risk by owning bonds over SPACs (in a rising rate environment too).
For your fixed-income exposure, why would you own bonds over SPACs?
Not only can one generate a higher return owning SPACs, given yields are much greater, but investors can do it with decreased risk given the significantly lower duration and mitigated credit risk. One tradeoff is that SPACs are less liquid, and should be purchased to be held to maturity (i.e. redemption).
Sounds too good to be true?
But wait, there’s more!
SPACs can be seen as discounted T-Bills stapled with an equity call option. This equity call option is manifested through upside optionality related to a favourable deal announcement, in which the SPAC can trade materially above the value of its T-Bills in trust and allow investors to exit at a premium to net asset value. This scenario will enable investors to generate outsized returns materially higher than the 3.4% yield offered through SPACs.
Source: Google Finance
For example, in December, CF Acquisition VI announced a business combination with Rumble. The associated investor enthusiasm lifted the shares to a 26% premium above its net asset value, exhibiting the upside optionality available from the asset class. (Disclosure: the Accelerate Arbitrage Fund (TSX: ARB) acquired CF Acquisition VI units in its IPO, divested the SPAC common shares post-deal announcement, and continues to hold the associated warrants to be monetized upon closing).
Faced with low yields, but deeply concerned with risk management, investors are trying to balance return on capital with return of capital. Discounted SPACs present the best of both worlds – downside protection through ownership of redeemable trust holding T-Bills along with yields equivalent to corporate bonds.
It is possible to increase return and lower risk in your bond portfolio. It just requires a little creativity.
The Accelerate AlphaRank SPAC Monitor details various metrics on the current opportunity set while offering details on every individual SPAC currently outstanding. The Accelerate AlphaRank SPAC Effective Yield tracks the average arbitrage yield offered in the market. The Accelerate AlphaRank SPAC Index tracks the price return of the SPAC universe.
* AlphaRank is exclusively produced by Accelerate Financial Technologies Inc. (“Accelerate”). The Accelerate Arbitrage Fund may hold a number of securities discussed in this research. Visit AccelerateShares.com for more information.
