SPAX Q1 2022 Commentary & Outlook

Image of Jim Robinson, Founder, CEO & CIO of Robinson Capital Management
Jim Robinson, Founder, CEO & CIO of Robinson Capital Management
Q1 was a challenging quarter for most markets for various reasons, including the highest inflation in 40 years.

The Robinson Alternative Yield Pre-Merger SPAC ETF (ticker: SPAX) completed its third full quarter. The Fund returned 0.06% for the quarter on a price basis and 2.27% for its first three quarters; it returned 0.02% on a net asset value basis for the quarter and 2.35% for the three quarters. Following is the Q1 2022 and trailing 9-months attribution analysis for the Fund’s NAV return relative to its benchmark index (Bloomberg 1-3 Year Government/Credit Bond Index), as well as other alternative yield strategies:

Table illustrating SPAX NAV and Market Returns

Q1 Performance Returns

The total expense ratio for the Fund is 0.85%. The net expense ratio is 0.50%, based on a contractual waiver until 12/19/2022.

The performance data quoted above represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than their original cost and current performance may be lower or higher than the performance quoted above. Performance current to the most recent month-end can be found here.             

WHY PRE-MERGER SPACS

The Fund invests exclusively in pre-merger Special Purpose Acquisition Companies (SPACs) because that is the only time in a SPAC’s life in which it behaves similar to a bond. In fact, SPAX remains the only ETF that has specifically hard-coded into its prospectus that it intends to exit any SPAC prior to the completion of a merger. The intent of the Fund is to provide a higher yielding and less volatile alternative to traditional fixed income and/or other low volatility alternative yield strategies. 

Q1 WAS CHALLENGING AND NOT AN IDEAL TIME TO GO PUBLIC 

It was a challenging quarter for most markets. If rising rates, widening credit spreads, the most hawkish U.S. Federal Reserve Board (Fed) rhetoric in decades, and a pesky 7.9% inflation rate (year-over-year CPI reported in March ’22), the highest in 40 years, wasn’t enough, along came the Russian invasion of Ukraine for markets to grapple with. As a result, equity valuations (Russell 100o Equity Index) were down 5.1%, the broad market bond index (Bloomberg Aggregate Bond Index) was down 5.9%, and the Commodity Research Bureau Index was up 27% for the quarter. Not the ideal environment to take a private company public. 

IT WAS A QUIET QUARTER FOR SPACS IN GENERAL

We started the quarter with 573 SPACs looking for a merger partner. Given the aforementioned environment, it was a relatively quiet quarter in terms of new SPAC issuance, and an even quieter quarter in terms of deal announcements. There were 55 new SPACs that came to market in the first quarter—down substantially from the 250 new issues we saw in the previous two quarters. Likewise, deal announcements, which had been consistently averaging 60 per quarter for much of the last year, were down to 30 in the first quarter. The slower pace of deal announcements largely explains the drawdown in the overall Pre-Merger SPAC Universe for the quarter. Warrant prices were basically cut in half during the quarter, as market participants are putting lower probabilities on many of these SPACs ever finding a deal prior to redemption date. In the previous two quarters, our performance benefitted from a higher participation rate in some of the better received deal announcements. This quarter, it was our underweighted exposure to warrants relative to the overall Pre-Merger SPAC Universe, that accounted for much of our strong security selection. 

BOND ALTERNATIVES TEND TO SWAP ONE RISK FOR ANOTHER

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 Fed has indicated, based on its own “dot plot” which projects the median expected rate change by FOMC members, a minimum 2.5% increase in short-term yields by the end of 2023 and a likely reduction of the $8 trillion expansion to its balance sheet over the past 12 years, we think now would be a prudent time to avoid unnecessary risks.

OUR LIST OF RISKS TO AVOID FOR THE NEXT 12-18 MONTHS

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. There is an alternative solution to traditional bonds that helps to mitigate those unnecessary risks and helps to accomplish the counterbalance to risk assets that bonds did so well in the 30 years preceding the Great Financial Crisis.

We believe the following are our top 5 reasons for WHY NOW for the Robinson Alternative Yield Pre-Merger SPAC ETF (SPAX): 

  1. Potential Higher Yield: while pre-merger SPACs haven’t generated much income historically, they do have a yield due to their redemption date and value. The cheapest 100 pre-merger SPACs offered a yield-to-worst (i.e. that implies that none of the SPACs ever finds a merger partner) of 2.9% at the end of the quarter plus, we believe their income generation could increase substantially if the Fed raises rates as much as it currently anticipates over the next 12-18 months—the yield of the overall investment grade bond market, as measured by the Bloomberg Aggregate Bond Index (the entire investment grade investable domestic bond market), was less than 3% at quarter-end.
  2. Downside Mitigation: pre-merger SPACs have credit and interest rate risks similar to T-Bills (AAA rating), whereas the Bloomberg Aggregate Bond Index has an average credit quality rating of AA(1) (a notch below the credit rating of T-Bills) and a duration (a measure of a bond’s sensitivity to changes in interest rates) of 6.6 years (as an example, a hypothetical 1% rise in rates would mathematically produce a 6.6% price decline in the index).
  3. Upside Potential: as we saw in previous quarters, any merger announcement shortens the time for the SPAC to earn back its discount; and a positive market reaction to a merger announcement could potentially push SPAC prices well above their redemption values.
  4. Opportunity for Absolute Return: Pre-Merger SPACs bought at a discount can be held to redemption for an opportunity of an absolute return. At the end of the quarter, the equal weighted universe of pre-merger SPACs was trading at an annualized yield-to-worst of 2.3% and an average time to maturity of 10 months. A comparable maturity Treasury zero coupon bond, held to maturity, offered a yield of 1.5% at the end of the quarter.
  5. An Optional 40% Solution: we believe the potential for a higher yield, true downside mitigation, mitigated interest rate or credit risk, and meaningful upside potential, provides a better 40% solution than traditional fixed income strategies.

Definitions:

1 The Bloomberg 1-3 Yr Government/Credit Index is a broad-based benchmark that measures the performance of investment grade, US dollar-denominated, fixed-rate Treasuries, government-related and corporate securities with 1 to 3 years to maturity.

1The HFRX Absolute Return Index measures the performance of absolute return hedge fund strategies that report their results to Hedge Fund Research.

3The HFRX Convertible Arbitrage Index measures the performance of convertible arbitrage hedge funds that report their results to Hedge Fund Research.

4The HFRX Merger Arbitrage Index measures the performance of merger arbitrage hedge fund strategies that report their results to Hedge Fund Research.

5 S&P ratings represent Standard & Poor’s opinion on the general creditworthiness of a debtor, or the creditworthiness of a debtor with respect to a particular security or other financial obligation. Ratings are used to evaluate the likelihood a debt will be repaid and range from AAA (excellent capacity to meet financial obligations) to D (in default). In limited situations when the rating agency has not issued a formal rating, the security is classified as non-rated (NR).

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