Comprehensive Study of Special-Purpose Acquisition Company (SPAC): An Investment Perspective

By | July 8, 2021


Special-Purpose Acquisition Companies (SPACs) have been widely discussed over the past year. According to the U.S. Securities and Exchange Commission (SEC), a SPAC is created specifically to pool funds in order to finance a merger or acquisition opportunity within a set time frame. A SPAC has 24 months after the initial public offering (IPO) to search for a target business and complete the acquisition. The acquisition decision must be approved by the shareholders, otherwise the management team would have to resume target searching.

Our recent paper provides a general overview of SPACs, their capital structure, market participants, characteristics of the management team, and the factors leading to their rise in popularity. We then look into how investment strategies could be formulated to tap into the potential revenue from investing in SPACs.

Abnormal Returns Analysis of SPACs

In our paper, we performed abnormal returns analysis on SPACs with both the CAPM and the Fama-French 3-Factor models. We categorized SPACs into different sectors based on the initial target industries stated in their listing statements, including Energy, Healthcare, Financial, Materials, Technology, Industrial, Common Goods, Communication Services, Real Estate, and MISC. Only SPACs in the Financial and Industrial sectors have positive average abnormal return in different time periods from the IPO, but the average abnormal returns of these two sectors are not high. SPACs might not appear to be a favorable investment option if investors solely look at the results in these two models.

However, when we calculated the excess return by subtracting the S&P 500 return from the SPACs’ returns, many sectors showed positive average excess returns in the period between IPO and merger completion. This indicates that the stock returns of SPACs can actually outperform the market. Therefore, it is worthwhile for investors to conduct further research to formulate a short-term investment strategy that could achieve considerable profit in SPACs.

The positive excess return that emerges in the period between IPO and merger completion in various sectors could be due to the dramatic rise in SPAC’s stock prices when the market receives news related to the potential merger. This provides the opportunity for investors to capture the excess return, and therefore formed the ground on which our strategy stands.

Strategy Design

In the design of our SPAC investment strategy, we used trading volume as a proxy to indicate whether or not, or at which time point, the investor should buy the SPAC. Trading volume would increase dramatically before the announcement of the merger, as private information may stimulate insiders’ buying of SPAC prior to the news release. Thus, the increased trading volume can hint at a potential announcement of merger news and the subsequent rise in the SPAC’s stock price. On the other hand, if any bad news is to be announced, insiders would also sell their stocks prior to the news release to prevent losses. Therefore, we added a constraint to our strategy, in which the qualified SPACs must have a positive change of stock price to indicate the buying pressure of insiders. Also, considering that SPAC trading volume can be very low in the beginning, we added another constraint to our strategy to ensure the average trading volume must be greater than a certain threshold.

After optimization of the strategy, we will buy SPACs when their trading volumes are larger than, or equal to, four times the 20-day moving average trading volume, and with average trading volume larger than 1,000,000. Moreover, the percentage changes of those SPACs’ stock price that day must be greater than 3%. We will then hold the qualified stocks for 10 days or sell them if our losses in their positions are larger than 15%.

Strategy Back test

This strategy was back tested using the data of SPACs listed between 2018 and 2021 from The stock price data and trading volume data was obtained from Yahoo Finance.

According to the back test, there are no SPACs that fulfil all the strategy’s criteria until December 2019. However, cumulative return of our strategy from 2018 to 2021 is 281.68%, while that of S&P 500 is only 53.38% for the same period. Meanwhile, the Sharpe ratio of our strategy is about 2.59, which is significantly higher than that of S&P 500, which is only 0.63 as of February 28, 2021 (data by Morningstar Inc.)

However, as our strategy does not include any trades until December 2019, our back test mainly reflects the 2020 return. Therefore, the effective back test period was only 1 year and 4 months (from January 2020 to April 2021). Further forward testing is required to confirm the strategy’s ability to outperform the market.

We also performed regression analysis using both the CAPM model and Three Factor model to calculate the abnormal return (alpha) of our strategy in the period of 2018 to 2021. In this period, abnormal returns of our strategy are slightly positive (0.002) in both CAPM and Three Factors Model analysis. The p-values of the two alphas are 0.062 and 0.078 respectively, indicating that the results are not statistically significant.

We hope our paper provides a new perspective on investing in a new kind of entity. Further studies should focus on the relationship between the percentage of outstanding shares traded per day and the abnormal return of SPACs in order to advance the reliability of our strategy. 

Eason Chong is a Master of Science in Finance student at the University of Illinois Urbana-Champaign

Emily Zhong is a Master of Science in Finance student at the University of Illinois Urbana-Champaign

Fannie Li is a Master of Science in Finance student at the University of Illinois Urbana-Champaign

Qianyi Li is a Master of Science in Finance student at the University of Illinois Urbana-Champaign

Saharsh Agarwal is a Master of Science in Finance a student at the University of Illinois Urbana-Champaign

Tony Zhang is an Instructor of Finance at the University of Illinois Urbana-Champaign

This post is adapted from their paper, “Comprehensive Study of Special-Purpose Acquisition Company (SPAC): An Investment Perspective,” available on SSRN.

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