SPACs, Thematic ETFs and the Perpetual Hunt for Investing’s Next Big Thing

Editors’ note: MarketMinder doesn’t make individual security recommendations. Those mentioned herein simply represent a broader theme we wish to highlight.

Investor optimism is widespread today—rationally so, in our view. But rising optimism often spurs greed, which can invite big mistakes. Opportunities to act on that emotion abound today, especially as headlines trumpet the excitement—and hot returns—surrounding SPACs (special-purpose acquisition companies) and thematic exchange-traded funds (ETFs). (And, um, meme stocks chased by users of a certain freewheeling Internet forum, but this article isn’t about that.) We caution investors against getting carried away with these stories. (And, we guess, against chasing heat generated by users of a certain freewheeling Internet forum, but again, this article isn’t about that.) If you are investing to fund retirement (or some similar long-term goal), buying today’s narrow highflyers isn’t necessary to achieve your investment goals.

As we wrote in detail last November, SPACs are known popularly as “blank-check” companies. They raise money through an initial public offering (IPO) with the goal of finding a private firm and taking it public through a reverse merger. So if you buy fictional SPAC ABC and it buys fictional startup HydroGenZCarStop, you become the proud owner of stock in HydroGenZCarStop—now a public company after circumventing the traditional IPO route and associated paperwork. Thematic ETFs are narrow funds that invest in companies ostensibly related to a certain idea or trend—e.g., going “green,” technological innovation, veganism, etc.

Thematic ETFs and SPACs are popular today—despite a high-profile case of alleged fraud last year for the latter—thanks to widely touted examples enjoying gangbuster returns. Heck, there is even a thematic SPAC ETF! (Actually, several of them.) The pandemic may have also bolstered interest. Some experts worried virus fallout would hamper the traditional IPO market, and SPACs offered an avenue to raise capital. According to some industry observers, the traditional IPO process can take 12 – 18 months, whereas a SPAC reverse merger can wrap up within 5 months (and in some cases, 5 weeks). SPACs accounted for 56% of US IPO volume in the last 12 months—the highest on record—nearly trebling their share at 2020’s start.^[i] For thematic ETFs, some cite anecdotal evidence of investors stuck at home driving interest in investing in ideas—e.g., socially distanced lifestyles.

However, we see some notable caveats to keep in mind. Buying a SPAC means buying an IPO—and as the old saw goes, IPO stands for “it’s probably overpriced.” Given SPACs’ widespread attention and hype, interested buyers likely must pay a premium price.

Moreover, you don’t know what you are buying. The SPAC raises the capital and has two years to acquire a firm—otherwise, they return funds to investors—and they generally go public without a merger candidate in mind. You might not even know which industry they plan to target. You are buying a stock purely on the hope someone else will find a needle in a haystack—not a great thesis to own, in our view.

Investing in a thematic ETF also isn’t as straightforward as it sounds, and investors must do their research to ensure the marketed theme aligns with the fund’s holdings. For example, a vegan ETF’s largest holdings are giant, multinational Tech firms—probably not the first companies that comes to mind for those seeking to invest in an animal-free lifestyle, especially if they serve meat at their on-campus cafés.^[ii]

Moreover, how does a SPAC or themed ETF fit within your portfolio? You can’t know that with a SPAC until it acquires a company—and that acquisition may throw your designated sector weightings out of balance. Thematic ETFs usually focus on niche corners of the market and may be very undiversified, leaving your portfolio far out of sync with the broader market.

Heat chasing is another risk to consider, as is the high likelihood your thesis to own rests on quite widely known information. You can see this clearly in the thematic ETF space. A theme’s hype drives the idea to create an ETF, which takes several months to launch. In our view, markets are efficient discounters of widely known information, so by the time an ETF is public, its price reflects all the opinions and expectations surrounding the idea. Before buying into the hoopla, ask yourself: Do you know something about SPACs others don’t? Or, as one Wall Street Journal column wisely quipped, “If you think you’ve spotted a theme that other investors haven’t fully appreciated yet, ask yourself how come there’s already a thematic fund for it.”^[iii]

We aren’t inherently against these securities, but we don’t think any investment strategy should center on them. Buying a SPAC or themed ETF presumes successful investing depends on huge gains from concentrated positions in highflyers. We disagree: Investors seeking long-term growth should target market-like returns over the long term with a diversified portfolio designed with their specific goals, objectives and time horizon in mind. Sound boring compared to headlines cheering SPACs or friends boasting about their vegan ETF’s healthy gains?^[iv] Maybe. But today’s primary challenge, in our view, is maintaining discipline and sticking with a plan instead of giving into greed.

Right now it may be overly difficult to accept that, as greed seems to be only starting to bubble. But if we have the great year we expect, staying disciplined could get harder and harder. Remember: There is a rich history of people getting poorer by chasing flashy returns.