SPAX Q1 2022 Commentary & Outlook
The Robinson Alternative Yield Pre-Merger SPAC ETF (ticker: SPAX) completed its third full quarter....
We’ve been discussing the broken 60/40 Model for a few years now. It’s not that we have anything against bonds—I’ve been a bond manager for 37 years—it’s simply because bond yields are at a level where they are mathematically incapable of providing a principal protection cushion should rates rise, a meaningful yield advantage over stocks, or a negative correlation with stocks. Let’s examine why it worked so well for 40 years; why it hasn’t worked so well since the great financial crisis, why it can’t work now; and, how to fix it:
Why 60/40 Worked from 1978-2008
Potential Downside Protection—the higher the yield, the greater the principal protection cushion. The Bloomberg Aggregate Bond Index had an average yield of 8.0% and an average duration of 4.5 years over the 30 years from 1978-2008—enough income to withstand a 0.40% increase in rates in any quarter and still post a positive return.
Huge Positive Carry—bonds yielded 5% more than stocks, on average, over that 30-year stretch.1
Negative Correlation—for most of those 3 decades what was good for bonds was usually bad for stocks, and vice versa. The correlation between the two asset classes was negative 0.33.2
Why 60/40 Didn’t Work So Well from 2008-2020
Modest Principal Protection—the Bloomberg Aggregate Bond Index has had an average yield of 2.7% and an average duration of 5.5 years over those 12 years—a 0.13% rise in rates in any given quarter would completely erode the quarterly income.
Barely Positive Carry—the Bloomberg Aggregate Bond Index has yielded, on average, only 0.7% more than the S&P 500 over the past decade.3
Near Zero Correlation—since the Great Financial Crisis what has been good or bad for bonds has not necessarily been bad or good for stocks. Correlation between the two asset classes was negative 0.14.4
Why 60/40 Has Been Broken the Past 2 years
Minimal Principal Protection— the Bloomberg Aggregate Bond Index has had an average yield of 1.5% and an average duration of 6.4 years since the COVID pandemic—a 0.06% rise in rates in any given quarter has completely wiped out the quarterly income.
Negative Carry—the dividend yield for the S&P 500 has actually been, on average, higher than the yield on the Bloomberg Aggregate Bond Index the past two years—every dollar allocated from stocks to bonds actually reduced an investor’s expected annual income.
Positive Correlation—investors have become hyper-sensitized to central bank activities—what is good for bonds is good for stocks, and what is bad for bonds is bad for stocks (see Q1 2022 Returns: stocks down 5% and bonds down 6%, based on these indices). Correlations for the past two years have been positive 0.79.5
Most of the “alternative” solutions to traditional bonds involve minimizing one risk in exchange for another. Absolute return, merger arbitrage, convertible arbitrage, bank loans and/or private debt strategies all involve reducing or eliminating one risk, while taking on other, presumably more palatable, risks. In an environment in which the U.S. Federal Reserve Board (Fed) has indicated a minimum 2.5% increase in short-term yields over the next 12-18 months and a likely reduction of the $8 trillion expansion to its balance over the past 12 years,6 we think now would be a prudent time to avoid unnecessary risks. Specifically, interest rate risk, credit risk, leverage, liquidity and shorting would all be high on our list of RISKS TO AVOID over the next 12-18 months. We believe there is an alternative solution to traditional bonds that may help investors avoid all those risks and has the potential to accomplish the counterbalance to risk assets that bonds did so well from 1980-2010.Why Pre-Merger SPACs May Offer a “Fix” to the Broken 60/40 Model
Principal Protection —pre-merger Special Purpose Acquisition Companies (SPACs) are required by prospectus to invest in T-Bills and/or Treasury Money Market Funds—they actually benefit from rising short-term interest rates, which is particularly good in an environment in which the Fed anticipates raising short-term rates 2.5% over the next 12-18 months.
Potential Strong Positive Carry—pre-merger SPACs are trading at a 3% discount to their current Trust redemption value, and those Trusts are invested in the T-Bill rate, which based on T-Bill forward rates and Fed Funds Futures curves, is expected to average more than 1.25% over the next year. The expected yield of 4.25% (3% discount plus interest earned) is 3x the 1.41% dividend yield of the S&P 500.7
Minimal Correlation—pre-merger SPACs have exhibited 0.22 correlation with the S&P 500 and 0.10 correlation with the Bloomberg Aggregate Bond Index.8
Other than a small group of hedge funds and institutional investors like ourselves, pre-merger SPACs are not widely understood by the investing public. Wall Street marketed SPACs to retail investors as a way to participate in the next Amazon or Tesla. They could be that after they identify a merger partner, but from the time they go public with their first initial public offering (IPO) until the time they actually close a deal (i.e. pre-merger), they behave, for all intents and purposes, more like a bond. They have a redemption date and a redemption value, and the collateral (the money raised in the IPO is put into a Trust) is invested in T-Bills and/or Treasury Money Market Funds (i.e. no credit or interest rate risk). In an environment in which risk avoidance is going to continue to be critical, we believe the “Tale of the Tape” as of 3/31/22 tells the whole story:
We believe pre-merger SPACs offer a more attractive yield, avoid credit and interest rate risks, and the upside potential of stocks should one of them announce a merger deal that the market views favorably. These are features that are not available in a traditional bond portfolio. In an environment featuring rising rates, widening credit spreads, the most hawkish Fed in decades, and a pesky 8.5% inflation rate, the highest in 40 years , and on the current trajectory, we believe it may reach double-digits in the coming months thanks to the war in Ukraine, we think now might be the perfect time for investors to consider using pre-merger SPACs as a risk-reducing and yield enhancing portfolio allocation.
Opinions expressed are subject to change at any time, are not guaranteed and should not be considered investment advice.
1Average yield differential between Bloomberg Aggregate Bond Index Yield-to-Worst and the dividend yield of the S&P 500 from 12/31/1977 - 12/31/2007.
2Historical Regression Analysis between quarterly returns of the S&P 500 and the Bloomberg Aggregate Bond Index from 12/31/1977 - 12/31/2007.
3Average yield differential between Bloomberg Aggregate Bond Index Yield-to-Worst and the dividend yield of the S&P 500 from 12/31/2007 - 12/31/2020.
4Historical Regression Analysis between quarterly returns of the S&P 500 and the Bloomberg Aggregate Bond Index from 12/31/2007 - 12/31/2020.
5Historical Regression Analysis between quarterly returns of the S&P 500 and the Bloomberg Aggregate Bond Index from 3/31/2020 - 3/31/2022.
6Federal Funds Futures Implied Rate
7Based on the S&P 500 Index Factsheet for 3/31/2022.
8Historical Regression Analysis between the Robinson Pre-Merger SPAC Index and the S&P 500 from 12/31/2017 - 3/31/2022 and the Robinson Pre-Merger SPAC Index and the Bloomberg Aggregate Bond Index from 12/31/2017 - 3/31/2022.
9The Pre-Merger SPAC characteristics are based on the most attractive, on an annualized yield-to-redemption basis, 50 pre-merger SPACs in the Robinson Capital Pre-Merger SPAC Index. ALL pre-merger SPACs are required by prospectus to hold T-Bills (with maturities less than 6 months) or Treasury Money Market Funds.
Credit Risk - The potential of loss resulting from a borrower's failure to repay a loan or meet contractual obligations.
Interest rate risk - The possibility for investment losses that result from a change in interest rates.
Liquidity - How quickly an asset or security can be converted into ready cash.
Robinson Pre-Merger SPAC Index - Robinson Capital maintains a pre-merger SPAC Index on Bloomberg. The index tracks the performance of SPACs from their IPO to either their redemption date or merger date, whichever comes first.
Shorting - Selling a security at a given price without possessing it and purchasing it later at a lower price.
Jim Robinson is the founder of Robinson Capital Management, LLC and serves as Chief Executive Officer and Chief Investment Officer. Jim is a veteran investment manager and bond trader with more than three decades of experience. Jim holds an MBA from Carnegie Mellon University, as well as a BBS in Finance and Economics from Wayne State University.