SPACs have generated a $39 billion frenzy in the US this year. The executive behind their first ETF explains how retail investors can use them to level the playing field with Wall Street titans like Warren Buffett.

  • US SPACs have raised $39 billion year-to-date and accounted for one-third of all US IPO activity since the start of 2019, according to Goldman Sachs Global Investment Research. 
  • This SPAC frenzy reached the exchange-traded fund industry when the first US SPAC ETF — the Defiance Next Gen SPAC Derived ETF — started trading on October 1. 
  • Paul Dellaquila, president of Defiance ETFs, breaks down why he believes a SPAC ETF can provide retail investors with access to IPOs once reserved only for institutional and high-net-worth investors.
  • Other market participants point out the high-risk and high-reward nature of the asset class and suggest that retail investors proceed with caution and conduct their own due diligence. 
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Special-purpose acquisition companies have made a comeback. 

According to Goldman Sachs research, US SPACs have raised $39 billion year-to-date, tripling the $13 billion they raised in all of 2019. 

Known as blank-check companies, SPACs raise capital from investors by listing shares on a public exchange. They then seek to merge with a private company within 18 to 24 months, thus taking the company public in a much shorter and less onerous process compared to the traditional IPO.

A total of 134 companies have gone public this year by merging with a SPAC, according to SPAC Research.

Birth of the first US SPAC ETF

In a sign of the SPAC frenzy hitting the exchange-traded fund industry, the Defiance Next Gen SPAC Derived ETF started trading on the New York Stock Exchange on October 1. 

But the firm behind the first US SPAC ETF — Defiance ETFs — reserved the catchy ticker "SPAK" in August last year, according to Paul Dellaquila, a former iShares executive who is now the president of Defiance.

"The reality was the market at that point was probably still a little too mature to go forward," Dellaquila said.

An encounter with index provider Indxx at the Inside ETFs conference in January this year reactivated their plan and the two teams went to work. 

Eight months later, the end product is an ETF that tracks a basket of 36 holdings — with 80% of them being stocks of companies that have already gone public via SPACs and 20% of them being newly listed SPACs. 

What first led Dellaquila and his team to the idea of a SPAC ETF was "the closed-off environment of the traditional IPO process."

"Investment banks, underwriters and high-net-worth people like Warren Buffett get to participate in hot IPOs like Snowflake and they got in at $120 a share," he explained. "However, mom-and-pop investors and the average Joe got access to Snowflake at $240 a share and that's just on the first day."

"So it doesn't leave a lot of meat on the bones for individual investors to pay almost 100% premium on what high-net-worth investors got," he said. 

With SPACs, retail investors can buy the publicly-traded blank-check company and wait for them to acquire or merge with their partners of choice. 

"If the IPO is successful and it goes through, you participate in that just like everyone else. I think that is the appeal to investors," he said, pointing to DraftKings (DKNG) as an example.

The sports-betting company, which was the fund's largest holding at almost 18% and went public via a merger with SPAC Diamond Eagle Acquisition in April, has gone up over 380% year-to-date. 

But not every one of these SPAC mergers is going to work or generate crushing returns, Dellaquila warned. 

"That's why an ETF makes sense because you're getting exposure to a well-balanced portfolio diversified across pre-SPAC IPOs as well as IPOs derived from SPACs," he said.

Retail investors seem to agree. The fund traded 566,000 shares and picked up 21 creation units on its first day, making it a nearly $15 million ETF launch, according to Dellaquila. 

"That's a good start for a new ETF, indicating there's strong retail demand," said Todd Rosenbluth, head of ETF and mutual fund research at independent research firm CFRA. 

Rosenbluth said that several recently launched thematic ETFs such as the Roundhill Sports Betting & iGaming ETF, Global X Telemedicine & Digital Health ETF, and the Direxion Work From Home ETF have all "come out of the gate strong providing exposure to a unique strategy."

"Many advisors and institutional investors will hold off buying a new ETF, but retail investors will often latch on to a compelling story," he said. 

High risk, high reward

However, part of what makes SPACs a compelling investment is also a source of risk, warned Sameer Samana, senior global market strategist at Wells Fargo Investment Institute. 

By merging with a SPAC instead of filing for a traditional IPO, companies face much less regulatory scrutiny. While that may speed up the IPO process, it also leaves individual investors with less information for due diligence. 

"In some ways, what is positive for the company maybe can leave investors a little bit less informed," he said. 

The risk is not lost on Julian Klymochko, the CEO and chief investment officer of Accelerate Financial Technologies, a Calgary, Canada-based ETF shop that claims to have launched the "first and only SPAC-focused ETF."

"The SPAC structure has allowed regular retail investors to access late-venture-capital type of deals taking place in the public markets," said Klymochko. "But you need to be aware that late-stage VC deals are very risky."

"It's a different type of investment that certainly opens up access, but you need the expertise to do anything in investing and that requires due diligence."

Klymochko's Accelerate Arbitrage Fund, which trades under the ticker "ARB" on the Toronto Stock Exchange, utilizes a SPAC arbitrage strategy where it aims to buy shares of pre-acquisition SPACs at a discount to net asset value and sell at a premium to NAV after the SPACs announce deals.

If a SPAC fails to reach a deal before its deadline, or if too many investors redeem in the case of a bad deal, the SPAC will liquidate and distribute $10 per share plus accrued interest to investors, Klymochko explained. 

"SPAC presents what I call equity upside with treasury bond risk. It's a really interesting risk-reward dynamic such that I consider it a separate asset class," he said. "Owning pre-deal SPACs means you can capitalize on not only the upside participation on the deal, but more importantly the downside protection."

Unlike "SPAK" which tracks the Indxx SPAC & NextGen IPO index, "ARB" is an actively managed fund that currently has 60% of its portfolio allocated to SPACs, according to Klymochko.

"Historically, post-SPAC equities have had relatively poor performance on average," he said, adding that this is where he takes issue with Defiance's SPAC ETF that has an 80% weighting to post-SPAC stocks. 

"They are these new companies and there's no more redemption in the future with accrued interest," he said. "So the risk-reward changes dramatically such that it converts from this T-bill with equity upside type exposure to just a straight post-SPAC stock," he said. 

To be sure, the Defiance SPAC ETF has a 20% allocation to pre-deal SPACs. Dellaquila, who had spent over 10 years with BlackRock's iShares unit, said he believes in strict, rules-based investing. 

"Active managers, they are going to make bets. Sometimes it's going to go well, sometimes it's not," he said. "We are going to give you a diversified approach."

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