Justin M. Follmer, MBA, CFP®, AIF®, Author at Financial Planner and Investment Advisor

IPOs, SPACs, and Direct Listings

July 6, 2021 by Justin M. Follmer, MBA, CFP®, AIF®

Investors are flooded with information, options, and little guidance when choosing what investment vehicles to put in their investment accounts. During and post-Pandemic, many of these options became household names as some investors worked from home and became quasi-day traders in their free time. The rise of popular MEME stocks via Reddit and access to free trading platforms, like Robinhood, resulted in the rapid rise of certain stocks, more interest in SPACs and IPOs as investors looked for the next best thing, in my opinion. However, an understanding of SPACs, IPOs, and Direct Listings would serve investors well before they allocate their hard-earned dollars. Many of our clients’ portfolios include the mutual funds and exchange-traded funds managed by Dimensional Fund Advisors. For that reason, we thought it would make sense to get their take on SPACs, IPOs, and Direct Listings. Here’s their approach:

Investors have long recognized that the reasons why companies elect to go public include access to greater fundraising opportunities, improved liquidity for investors, and/or a lower cost of capital. More recently, however, investors have considered the implications related to how companies go public. Historically, the most common path to enter public markets was through an initial public offering (IPO), and while IPO activity remains vibrant, entryways such as direct listings and special purpose acquisition companies (SPACs) have drawn fresh attention. Consequently, investors have been forced to evaluate what, if any, impact these roads less traveled may have on investment decisions. We examine IPOs, SPACs, and direct listings and show that, although each route is characterized by unique terrain, regardless of the path to public markets, the end result is a new public company trading in competitive and liquid equity markets.

Traditional IPOs

In a traditional IPO, the company issuing new equity hires an investment bank to provide underwriting and advisory services for the offering. The investment bank helps pitch the company to potential investors, commonly via what’s known as a roadshow, in an effort to introduce the company to investors, drum up demand for the shares, and subsequently formulate an initial offering size and price that reflect investor interest. Investors awarded an allocation purchase shares through a primary market transaction, following which the shares are listed on an exchange and available to trade.

IPOs represent the most familiar portal to public markets, and while activity levels can vary with market conditions, they remain a popular thoroughfare. Our research highlights a few IPO features that can impact aftermarket pricing, such as underwriter pricing support and shareholder lockup agreements. At Dimensional, we avoid purchasing IPOs for up to one year to alleviate the potential impact of such post-offering activities.

SPACs

SPACs are a modern version of a “blank check” company designed to use cash raised in an IPO to merge with or acquire an operating company. When the target is a private company, the transaction works like a reverse merger, allowing the private firm to enter the public market. While the vehicle has been around for decades, SPAC activity rose to new heights in 2020 and continued to outpace historical levels through the first quarter of 2021. For example, Exhibit 1 shows that SPACs raised over $150 billion in total capital across more than 500 SPAC IPOs during the 15-month period ending in March 2021. To put those figures in context, the recent SPAC activity levels exceeded those of concurrent common stock IPOs in both volume and proceeds, as well as the aggregate SPAC totals over the preceding 10-year period.

The current fad has placed SPACs under the spotlight, but the use of blank check companies as a path to public markets has also been in vogue at various times in the past. Therefore, it is important that investors understand the vehicle’s mechanics and the associated price discovery process, regardless of whether current activity levels are sustainable. First, unlike a traditional offering where issuers hold discretion over the use of funds, the money raised in a SPAC IPO is held in a trust until a target company is identified and a subsequent business combination, or the de-SPAC transaction, occurs. Following shareholder approval of the transaction, the SPAC operators can access the capital to help fund the acquisition or merger. If no deal occurs within a specified period, typically two years, the SPAC is liquidated and the cash held in the trust is returned to shareholders.

Another common SPAC feature allows investors to redeem their shares in exchange for the initial offering price plus interest prior to the completion of the proposed de-SPAC transaction, effectively serving as a backstop for the share valuation. As a result, SPACs typically trade near their IPO price until a deal is announced. Once a deal is completed, SPAC shareholders’ ownership in the shell company is swapped for a stake in the new public operating company, and the shares trade subject to the same pricing mechanisms in effect for the broader public equity marketplace. At Dimensional, SPACs are not eligible for purchase in our portfolios until the SPAC combines with an operating company and the stock represents equity in an operating business. Consistent with our approach to investing in traditional IPOs, we also require the expiration of any price support activities and lockup agreements before the new public entity is eligible for purchase.

Direct Listings

Another avenue used to enter public markets is a direct listing, in which a private company lists its equity shares directly on an exchange without conducting an underwritten offering. Recent modifications to the eligibility requirements by both the NYSE and NASDAQ served to expand access to the direct listing corridor. This notably allowed for a few well-publicized new listings, like Spotify and Slack, though there have only been a handful of direct listings in total in recent years. However, the direct listing process continues to evolve, and new innovations, such as the ability to raise capital via a direct listing, have emerged that may attract additional entrants. Therefore, it is important that investors be cognizant of the direct listing process and the relevant pricing mechanisms to allow for informed decision making.

Before shares are made available to trade on a public exchange, the direct listing company and its financial advisor work together to establish the initial reference price based on a recent private-market transaction or an independent valuation. The reference price is then used in an auction process coordinated by a designated market maker on the first day of trading, similar to the way each stock opens for daily trading. Prior to December 2020, direct listings were not permitted to raise capital and the initial liquidity was provided exclusively by early investors and employees. As a result, lockup provisions have not been common, but that may change if firms leverage the direct listing process to raise new capital.

Choosing the Optimal Path

Private companies must evaluate and choose their desired path depending on their targeted objectives and constraints. Companies may choose to go public via a traditional IPO to allow investment banks to pitch the company to a diverse set of potential investors, while other companies may choose to merge with a SPAC to expedite the listing process or because the company believes the SPAC operators provide an additional source of value to the company. Alternatively, companies that don’t want or need underwriter services may choose a direct listing to cut down on the costs associated with going public. Exhibit 2 summarizes the key path characteristics that companies may use to differentiate between the available options.

Implications for Investors

The paths to public markets have come into focus of late due to increased activity in nontraditional entryways, such as SPACs and direct listings. No matter the vehicle chosen to navigate the transit, once a company enters the public marketplace, it becomes subject to the same interactions between the supply and demand for securities that shape equity prices each day. We remain sensitive to the relevant price discovery process associated with IPOs, SPACs, and direct listings, and account for characteristics such as lockup agreements in our eligibility guidelines. However, beyond those considerations, we can apply our systematic process to extract information about expected returns for new listings just as we would for any other publicly listed security. Hence, investors can take solace in the fact that, whether a company takes the road less traveled or follows the beaten path, we can rely on the drivers of expected returns—size, relative price, and profitability—to point the way forward. Interested in pursuing an investment strategy backed by decades of academic research? Get in touch today.

Disclosures:

Article written and published with permission by Dimensional Fund Advisors with edits by Coastal Wealth Advisors, LLC.

Inflation Surprise, Really?

May 18, 2021 by Justin M. Follmer, MBA, CFP®, AIF®

It’s been a volatile week. For the better part of six months, investors haven’t seen a material pullback like we are seeing right now. Several newsletters ago (available only to clients), I stated “a strong recover is likely, but we can’t rule out a market correction on any potential negative catalysts.” It seems we now have that catalyst in the form of a spike in inflation.

Let’s put this in perspective so we are all on the same page.

Wednesday’s Consumer Price Index (CPI), the widely accepted measure of inflation, came in at 0.8%, the highest in 13 years and was much higher than the 0.2% predicted. This pushed the year-over-year number to 4.2%, much higher than the 2.6% from March’s reading. But we have to take this in context…what was happening in March/April 2020? You guessed it, lockdowns.

Since then, we’ve seen massive amounts of stimulus, a 25% increase in the M2 money supply, a 2×4 piece of lumber almost double in price, housing values significantly higher, and extra unemployment compensation that’s causing a labor shortage and price increases. Are we really surprised by a spike in inflation?

So if it was kind of expected, why are the markets acting like an angry toddler? In my opinion, markets were overextended from the past several months of rallying. Any negative catalyst that could imply the Fed tightening monetary policy sooner than they’ve stated was enough to cause this pullback. Recall the Fed “not even thinking about thinking about raising rates?” Yeh, they may consider “thinking about it” now if next month’s CPI reading runs even hotter. In my opinion (and history is on my side), raising rates gradually, methodically, and transparently is far better for markets than trying to chase higher inflation with drastic increases to control it. The latter typically causes a recession. Being proactive is the key here and I certainly hope Powell & Co. (slang for The Fed) are smarter than me.

Am I allowing this to change my clients’ investment strategies? A resounding, no. These past few weeks have seen an increase in selling on the growth/tech side of the style box and buying on the value side. This has pushed value stocks higher and my clients have benefitted from this. Even during broad market down days, we see the value side perform less-badly than growth. Why are we positioned this way: Our Investment Philosophy.

Should we add inflation hedges?

The best long-term inflation hedge is equity exposure, in my opinion. Even during these short-term bouts of volatility, equities are typically the best bet. Other inflation hedges are Treasury Inflation Protected Securities (TIPS) and ultra-short bonds for conservative clients. Real estate exposure and commodities (gold, oil, raw materials, etc.) are hedges as well. But none of these have the long-term track record that equity exposure provides. Since my clients are globally diversified, most of them own all of these already. I can’t make a case for timing our way into and out of concentrated positions specifically to hedge against inflation. Recall that we aren’t traders, we’re investors.

Higher inflation is a drain on purchasing power. So too are higher taxes. Both of which we are likely facing in the coming year. These questions remain:

How “hot” will inflation run before Fed intervention?
How much will taxes actually increase under President Biden’s proposal?
What other catalysts are we likely to face through the fractured reopening of America and the world?

For clients of Coastal Wealth Advisors, I monitor this information, among many others, daily and keep clients informed of issues relevant to their invested dollars, like inflation surprises. We maintain a passive approach to our investment philosophy, but an active approach to monitoring and rebalancing as needed. Monitoring is the final step of the financial planning and investment management process. It is in this phase of the process where I believe value is created. It’s crucial to be in contact with your advisor often. When’s the last time you heard from your advisory team? If your answer is more than a year, let’s chat. I believe there’s a better investment experience waiting for you. Get in touch here.

Is the Stock Market Divorced from Reality?

September 15, 2020 by Justin M. Follmer, MBA, CFP®, AIF®

By Weston Wellington, Vice President of Dimensional Fund Advisors, LP.

I have been sheltering in place on a former dairy farm in rural New Hampshire—surrounded by more Scotch Highland cattle than people—and relying on my iPhone and Microsoft Surface Pro to keep in touch with the office via email and Zoom video. I haven’t sat in a restaurant in six months, so my dining out costs are close to zero while my grocery bill is sharply higher. I venture out every 10 days or so to stock up on supplies (Hannaford supermarket, Walmart, Tractor Supply, Home Depot) and order frequently online. Judging by the traffic on my dead-end dirt road, I’m not the only one whose habits have changed. It’s only a small exaggeration to say every third vehicle going up or down the hill is a FedEx or UPS truck making another delivery, most likely from Amazon.

For many of us, the daily routine has changed dramatically from a year ago. This writer is no exception. I customarily travel extensively for business, with well over 100 airline flights and dozens of hotel stays over the course of a year. Since March 18, the number is zero on both counts, and the near future offers little reason to expect any change.

With this shifting landscape in mind, it shouldn’t be surprising that some companies have prospered during this upheaval while others—especially travel-related firms—have struggled. From its record high on February 19, 2020 the S&P 500 Index¹ fell 33.79% in less than 5 weeks as the news headlines grew more and more disturbing. But the recovery was swift as well: from its low on March 23, the S&P 500 Index jumped 17.57% in just 3 trading sessions, one of the fastest snapbacks ever among 18 severe bear markets since 1896. As of August 18, 2020 the S&P 500 Index had recovered all of its losses and notched a new record high.

Many individuals are puzzled by this turn of events. For those under the age of 75, the news headlines are likely the grimmest in memory: Millions have found themselves suddenly unemployed, and storied firms such as Brooks Brothers, Neiman Marcus, and JC Penney have entered bankruptcy proceedings.

How can stock prices flirt with new highs while the news is so discouraging? One financial columnist recently observed that the stock market “looks increasingly divorced from economic reality.”²

Is it? Let’s dig a little deeper.

The stock market is a mechanism for aggregating opinions from millions of global investors and reflecting them in prices they are willing to accept when buying or selling fractional ownership of a company. Share prices represent a claim on earnings and dividends off into perpetuity—current prices incorporate not only an assessment of recent events but also those in the distant future. In some sense, the stock market has always been “divorced from reality” since its job is not to report today’s temperature but what investors think it will be next year and the year after that and the year after that and so on.

Moreover, the universe of stocks does not march in lockstep. At any point in time, some firms are prospering while others are floundering. This year’s wrenching economic turmoil has inflicted great hardship on some firms while opening up new opportunities for others. Based on this admittedly abbreviated list, it appears the stock market is doing just what we would expect—reflecting new information in stock prices.

Past performance is not a guarantee of future results.

No one could have predicted the tumult we have seen this year in financial markets. But investors would do well to focus on what hasn’t changed.

1. Markets are forward-looking, so focusing on today’s economic data is akin to looking at the rearview mirror rather than the road ahead.

2. Broad diversification makes it more likely that investors capture market returns that are there for the taking—including companies that do far better than expected.

3. Since news is unpredictable, a strategy designed to weather both expected and unexpected events will likely prove less stressful and easier to stick with.

Bottom line: read the newspaper to be an informed citizen, not for advice on how to navigate the financial markets.

¹S&P data © 2020 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.
²Matt Phillips, “Repeat After Me: The Markets Are Not the Economy,” New York Times, May 10, 2020.

5 Real Things + Bonus Offer you can do Right Now to Address the Coronavirus and your Investment Account.

April 1, 2020 by Justin M. Follmer, MBA, CFP®, AIF®

Here’s 5 Real Things + Bonus Offer you can do Right Now to Address the Coronavirus and your Investment Account.

As the country continues its best efforts to slow the spread of the coronavirus, it seems that everywhere you turn, you cannot help but run into some article, podcast, Facebook post, television special or Tweet about the latest COVID-19 projections. We, investment advisors, are no different. In just a quick sample of my email inbox, there isn’t a single email within the last 3 weeks that hasn’t mentioned either “COVID-19” or “Coronavirus” and how to help clients address it through their investment account. Some of the common themes among these emails include:

“Here’s our fund that has beaten the S&P 500 year-to-date.”

“Buy this leveraged ETF to protect downside risk.”

“Sell this fixed insurance product to weather the current storm.”

“We offer a suite of software solutions to address market volatility.”

And so many others…that just get deleted.

None of these would help any of my clients and they likely won’t help you either.

Here’s 5 Real Things + Bonus Offer you can do Right Now to Address the Coronavirus and your Investment Account.

#1 Don’t Sell Anything

I’m not simply repeating what all financial advisors say during this time. I’m telling you that there is far more evidence in favor of not selling than there is in support of cashing in and choosing to buy back at another point in time when things “feel safer;” take a look at returns following market drawdowns. There’s one caveat to this: if you’ve been laid off and need money to pay your bills during this difficult time, that would be a reason to choose specific positions to sell to free up cash to live from.

How does this help you? Selling for selling sake is an emotional response. Many people struggle to separate their emotions from investing making it one of the single hardest things to do as an investor. When you sell, you miss rebounds. And some of the best market days are immediately following the worst days. If you aren’t invested, you’ll lock in losses without the ability to earn gains. Stay invested unless you fall into the caveat above.

#2 Understand Why Your Account Dropped in Value

Is it just your account or is it everyone else too? You likely own several investments within your account. These investments could be in the form of a mutual fund, an exchange traded fund (ETF), or a money market fund. There are many other types, but let’s focus on those three since they are the most prevalent in the typical investment account. Each of the different positions in your investment account are designed to pursue a specific strategy outlined in its governing document. This document is called a prospectus and you received a copy of it when you first bought the fund (hint: it’s that massive book you threw out a long time ago that was too big and boring to read). This document outlines the goal of the fund and how and why it invests the way that it does. You could call the fund company and request a copy and read it as you practice social distancing -or- you can take a shortcut. Head over to www.morningstar.com and enter your fund’s ticker symbol to get some quick, current data about the fund.

Let’s use an example. One of the most popular funds widely available in company sponsored retirement plans is the Vanguard Total Stock Market Index Fund, ticker symbol VTSAX. When you enter this ticker symbol in the search bar on the Morningstar website, it produces a page that shows you how the fund is invested. In this example, it’s a mutual fund that comprises of about 3,500 companies and is designed to track the entire US Stock Market.

How does this help you? If you know that the entire US Stock Market has decreased in value over the last several weeks as a result of both market panic and expectations of the future, it stands to reason that this fund would follow that same trajectory. Having this understand of why your fund decreased in value can help bring back perspective and understanding where you may not have it. Considering looking up each fund you own to gain this perspective.

#3 Understand How Each Fund in Your Account Works Together

Now that you know how to look up each fund, considering putting them together to fully understand your account in its entirety. To do this, you may need to purchase a paid version of Morningstar (costs about $200/year but there’s likely a free trial available) so you can see how each fund interacts with the others in the account.

How does this help you? Owning one total stock market fund, for example, diversifies your risk across the entire US stock market. But you can spread this risk even further. You can add other funds to see how they may have affected the recent drop in value. By adding fixed income or alternative funds that may be uncorrelated to the stock market, you can ensure parts of your portfolio don’t drop at the same rate as the general market. This is the very definition of diversification.

#4 Determine your Risk Score

The risk tolerance questionnaires in use by many firms are antiquated. There’s no other way to state this: they are terrible and do nothing to address the actual investment account level risk. They are also easy to game in that you can look at the answers and choose the ending outcome based on the range of answers. Several years ago, I partnered with Riskalyze to offer a unique scoring method to pinpoint my client’s specific risk metric. Think of it like the Sleep Number Bed System but for your investment account: you are scored between 1 and 99.

You can score yourself here.

BONUS OFFER: For as long as South Carolina is under a COVID-19 State of Emergency, I’ll take this a step further and add your investments to the scoring system so you can see if your portfolio matches your risk score…at no charge. Send a quick email to justin@coastalwealthadvisors.com for this offer with the subject: “Limited Time Offer: Risk Matching Request.”

How does this help you? When you invest your account to match your risk score, you have a far likelier chance of staying invested while working towards your financial goals. This helps you make better investing decisions through Riskalyze’s mission: “empowering the world to invest fearlessly.”

#5 Review your Beneficiary Designations and Estate Planning Documents

An often overlooked thing about an investment account is what happens to it following your expiration. Give your custodian (the company holding your investment account) a call and ask this question: “if I die, what happens to this account?”

You may be surprised to hear that a beneficiary isn’t listed or there’s “no record available.” Paperwork at custodians gets messed up all the time; trust me, I deal with them every day. Use this time to review your Beneficiary Designations, WILLs, Healthcare Directives, and Power of Attorney appointments to ensure the correct people are listed. If not, reach out to your estate planning attorney to start the update process. If so, please be sure your documents are signed and fully executed. I can’t think of anything more unfortunate than spending thousands of dollars on an estate plan and then having unsigned estate planning documents. Unsigned documents are not executed and won’t accomplish your wishes upon your expiration.

How does this help you? Our lives change all the time and it’s important that long-term plans reflect those changes. Close family members that may be listed as a trustee or executor may not be so close now. Staying on top of these things is very important. The last thing you want to happen is the very thing you’ve planned against while having the ability to ensure it doesn’t.

During this historic time in our country where economic activity has come to a halt and when markets have struggled to find direction, it’s tough to stay motivated and focused. We hope that you can follow these 5 Real Things and take advantage of our Bonus Offer that you can do right now to address the coronavirus and your investment account.

Here at Coastal Wealth Advisors, I work with each of our clients on all the above steps – and so many more. I do all the heavy lifting for you by spending countless hours with each family to address their financial goals and risk tolerance in order to implement financial plans and manage investment accounts on their behalf. I’d love nothing more than to help you right now. I’m equipped to work virtually and am fully dedicated to helping clients through all market climates. Consider reaching out today to learn more.

Please stay safe and healthy and remember, this too shall pass.

Portfolios and Coronavirus

March 12, 2020 by Justin M. Follmer, MBA, CFP®, AIF®

It goes without saying that the entire world is fixated on the near- and long-term ramifications the coronavirus, COVID-19, could have on the world’s population and resulting global growth expectations. Using the Russell 3000 as a widely available proxy for the entire US stock market, as of midday Thursday 3.12.2020, it was well into bear market territory. It is down -25.22% since the previous high set back in February.

What’s Causing the Markets to React so Fiercely?

Using the 1st Pillar of Our Investment Philosophy, we know that world markets are a giant information processing system, in that, market prices reflect all available information and expectations of the future. With stock markets entering bear market territories (defined as a drop of more than 20% from recent highs), it would indicate that global growth expectations are now less than they were just a few short weeks ago…the question is how much of an economic impact this will ultimately have on the economy?

“Market declines can occur when investors are forced to reassess expectations for the future,” read the latest publication from Dimensional, “the expansion of the outbreak is causing worry among governments, companies, and individuals about the impact on the global economy. We see this happening when markets decline sharply, as they have recently, as well as when they rise. Such declines can be distressing to any investor, but they are also a demonstration that the market is functioning as we would expect.”

With new cases of the virus popping up across the world, the concern for widespread infection with little containment, and no current vaccine, it makes sense that the markets are reacting to any signs of negative news. Yet it seems that positive news is hard to come by lately.

So Let’s start there; here’s some positive news articles you likely haven’t read.

Scientists are working 24/7 on potential vaccines, but they take time.

Supply chains are starting to come back online in China.

The US-China trade war unintentionally prepared companies for coronavirus.

Markets will likely get relief as more positive news happens and with confirmation that new cases are peaking or slowing over time or when a vaccine has been discovered. As of last check (3.12.2020 at 12:45pm EST), there are 56,864 active cases across the globe, with 90% of them (51,150) reportedly in Mild Condition; 10% (5,714) in serious or critical. This means that 68,677 have recovered. Unfortunately, 4,756 people have lost their lives. (source)

So…What’s next?

It’s impossible for anyone to determine the direction of this market until more reliable positive data takes hold. “From a macro-economic point of view, the real question is how this impacts the US economy over the coming year,” says Brian Wesbury of First Trust Portfolios in a recent email, “The US consumer is on solid footing…we believe, just like all other viruses we have seen over the past decades that have dissipated, the coronavirus will be no different.”

“We can’t tell you when things will turn or by how much, but our expectation is that bearing today’s risk will be compensated with positive expected returns. That’s been the lesson of past health crises, such as the Ebola and swine-flu outbreaks earlier this century, and of market disruptions, such as the global financial crisis of 2008-2009. Additionally, history has shown no reliable way to identify a market peak or bottom. These beliefs argue against making market moves based on fear or speculation, even as difficult and traumatic events transpire. (Source)”

The Takeaway

With markets continuing their slide, it’s important that you adhere to an investment strategy that was designed specifically for you. Clients of Coastal Wealth Advisors go through a robust risk tolerance assessment to test their commitment to a certain level of risk given their own emotional reaction to hypothetical changes in the value of their portfolio. It is this assessment that drives the portfolio design process. Combining this risk-based discussion with an Investment Philosophy rooted in academic science can make for a better overall investment experience. This is how we address negative market movements, like the coronavirus, long before they occur. We never have all of the answers about world events and it doesn’t mean that portfolios won’t fluctuate over time, but it does mean that the fluctuations should be in line with what you are willing to withstand when it may seem like everyone else is running for the hills. A better strategy, in my opinion and backed by academic evidence, is to build an allocation that marries your financial goals with your risk tolerance and is designed to weather market storms. In essence, build a portfolio that you can stick with during the good and bad times.

If you find yourself in a state of panic or uncertainty regarding your current portfolio, please get in touch with Justin today. Call him directly at 843-870-9568 or email justin@coastalwealthadvisors.com. He’d be happy to chat with you and provide you with honest feedback…even if it’s simply to do nothing.