The Economist December 4th 2021 Finance & economics 75G
reatfloodsaresupposedtowash
away the world’s ills. Facing a divine
deluge, Noah built an ark in which to
escape. In “Metamorphoses” Ovid, a
Roman poet, describes how Jove, king of
the gods, unleashes a flood to wipe out a
degenerate humanity: “now seas and
Earth were in confusion, lost; a world of
waters, and without a coast.”
Whether a flood has wiped out the
unworthy is a critical question for in
vestors in special purpose acquisition
companies (spacs). These are blank
cheque vehicles that raise capital
through initial public offerings, after
which their sponsors hunt for private
firms to take public via mergers. Al
though spacs have been around for
decades, they were once niche affairs.
Their structure was costly for investors,
and companies mostly avoided them.
Their popularity surged in 2020.
Between June 2020 and November 2021
more than 700 spacs were created, al
most eight times as many as in the pre
ceding 16 months. spacs have raised
$235bn since the start of 2020, a stagger
ing $97bn of it in the first quarter of 2021
alone. Everyone who’s anyone has spon
sored a spac, from Shaquille O’Neal, a
former basketball player, and Serena
Williams, a tennis player, to Gary Cohn, a
former banker at Goldman Sachs, and
Bob Diamond, erstwhile boss of Barclays.
Because they are listed pots of cash,
shares in premerger spacs tend to trade
near their ipoprice, usually $10. But
prices climbed late last year, peaking at a
premium of 15% this spring.
The hysteria ended in April after
regulators began to grumble. Prices of
premerger spacs tumbled and the pace
of spaccreation slowed. Mr Diamond
posits that this helped clear out the
muck. “Oh my goodness, has there been awashout.Thedaysofthecelebrityspacare
gone,” he says. The next phase, he argues,
will be about sponsors who have proven
track records and who can attract extra
capital from institutional investors keen
to gain exposure to newly listed firms. The
idea that spacs have been cleaned up is
widely held. But do the data support it?
The phase immediately preceding the
frenzy seems to have proved a poor bet for
investors. In October 2020 Michael
Klausner and Emily Ruan of Stanford and
Michael Ohlrogge of New York University
published a draft paper evaluating in
vestors’ returns. For spacs that merged
between January 2019 and June 2020,
these were dismal. The problems were
structural. Investors who buy a spac’s
shares during its ipoare often given free
“warrants”, the right to buy more stock in
the future. Around 5.5% of investors’
money is eaten up in underwriting fees.
Punters can claim their stake back at any
time, but that leaves the costs to be borne
by the rest. And when a deal is struck, the
sponsor typically takes 20% of the shares
issued. From every $10 raised, a median ofonly $5.70 was available for the merged
entity to spend.
As sponsors are only paid if they
arrange a merger, their incentive is to do
a deal, even at a high price. The fatter the
slice taken by sponsors and early in
vestors, the worse the stock performance
of the merged company. Firms that went
public via a spacbetween January 2019
and June 2020 underperformed the
Nasdaq composite, an index of American
stocks, by 64.1 percentage points in the
period to November 1st 2021.
The paper caused much consterna
tion among spacfans. “We have received
countless responses to our research,” the
authors noted in a postscript published
online on November 15th. “Most of which
amounted to ‘your study is out of date’.”
So they reran their analysis.
The authors found that there were
indeed some differences between the
original cohort and spacs created in the
six months after September 2020. The
second group experienced far fewer
redemptions, tended to issue fewer
warrants and attracted more capital from
institutional investors. As a result, cash
available for merged firms rose to $6.60,
per each $10 share. Still, spacs that closed
deals in the six months from October
2020 have underperformed the Nasdaq
by around 20 percentage points: an
improvement, but hardly stellar.
Crucially, there is little evidence of
lasting change. “It’s remarkable how
little innovation in structure there’s
been,” says Mr Klausner. Sponsor shares,
warrants and underwriting fees are still
present in much the same form. Re
demptions and warrants offered are on
the up again, and institutional invest
ment has begun to fall. The havoc of 2021
has not wiped away all of spacs’ ills. If
anything, it has left a lot of muck behind. ButtonwoodAfter the flood
The frenzy for spacs has waxed and waned. Has that changed how they work?days. Last year the fund’s Independent
Evaluation Office noted that the views of
India’s authorities and theimf on capital
controls had become more aligned (al
though the fund is still happier with allow
ing large exchangerate movements in re
sponse to external shocks than is the typi
cal Indian policymaker).
Nor is the capital that comes with index
inclusion entirely stable. Although inflows
triggered by inclusion are far less sensitive
to the domestic economic environment,
they are between three and five times more
sensitive to global financial conditions,
suggests imf research published last year.
Investors often trim their allocations to
riskier emerging markets and retreat to
safer assets like cash and American Trea
suries during times of market stress. The
fact that Indonesia was part of indices con
structed by Bloomberg and JPMorgan, for
instance, did not stop foreigners selling off
its government bonds in the panic of
spring 2020. Foreign ownership of the
country’s bonds had declined to 21% in Oc
tober this year, from 39% in December- Research by the Asian Development
Bank also finds that foreign ownership of
localcurrency bonds can increase the vo
latility of capital flows, particularly in the
least developed markets.
Still, international institutions are
hardly advocating stopping inflows alto
gether. In a report earlier this year the Bank
for International Settlements, a club of
central bankers, argued that deep and liq
uid financial markets, prudent monetary
and fiscal policy and strong company bal
ancesheets could act as buffers against the
sometimes volatile ebb and flow of capital.
If India is to realise the full benefits ofin
clusion, it will have to heed that counsel.n