IPOs, SPACs, and Direct Listings

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.

SPACs
Source: Dimensional using Bloomberg data. Sample includes all US common stock and SPAC IPOs with a minimum offering price of $5 for which data is available.

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.

SPACs

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:

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

Is the Stock Market Divorced from Reality?

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.

When Markets Drop

When Markets Drop

In the next couple of weeks, investors will begin receiving October portfolio statements from their custodians and may ask themselves what to do when markets drop. If you’re like most investors, you usually don’t take the time to check your account balances daily, online or through your mobile app, but rather only decide to look when you hear bleak headlines on the nightly news. And with recent headlines such as these, we can understand why:

“Stock market experts say this is a stumble, not a plunge”

“U.S. stocks close lower as Dow drops nearly 1,400 points in 2 days

“Market timers say it’s still too early to jump back into stocks”

“Dow drops more than 1000 points in two days

Here’s what to do when markets drop:
  1. Understand that articles are written to trigger an emotional response.
  2. Be rational and proactive, not emotional and reactive.
  3. Address “1,000+ point drops” long before they happen.
  4. Either hire an Investment Advisor with a Fiduciary Duty or have a battle buddy.

Journalists have a unique job; they pen headlines that are designed to invoke an emotional response to get readers to click on the article. And when markets drop, the headlines get more wild. More clicks = more traffic = more ad revenue. Let’s illustrate this point with two headlines. Which is more exciting?

“Dow Drops 1,000 points.”

“Dow closes down 3.7%.”

We’re willing to bet the “1,000 point” headline is more exciting for the mere psychological idea that 1,000 is larger than 3.7. But if the Dow is sitting at 27,000, these hypothetical headlines depict the same results, just written differently. While our example above is purely hypothetical, a seasoned investor needs to know when to dig deeper than flashy headlines.

The third principle of Our Investment Philosophy reads:

Emotions are Destructive. Reacting to current market conditions may lead one to making poor investment decisions at the worst times.

Market corrections and other major news events affecting the world tend to alter investor’s outlook about the future when markets drop. When you hear advisors suggesting you take a long-term approach, the advice can feel too cliché and ambiguous. We believe this advice is more about historical evidence and emotional pause rather than an effort to brush off the pain you may be feeling. When an investor is proactive, it means she has positioned her portfolio in a manner paralleled with market uncertainty. Recognize that markets rise and fall as they digest information daily. These movements are a fundamental part of being an investor and should be embraced rather than avoided. It is our opinion that one of the best ways to accomplish this is by having a globally diversified portfolio that pursues your financial goals and is based on your tolerance and capacity for risk. This means that rarely will you be 100% stocks, 100% cash, or 100% bonds. You’ll more than likely be a combination of each through all market conditions. How much of each is outside the purview of this blog post, but we’d love to sit down with you and build a portfolio just for you.

A principle of portfolio design is understanding the long-term characteristics and historical performance of a similar portfolio. While history may not be indicative of future results, it provides some insight into how one’s portfolio may have performed in past markets as well as the variability of returns over time. With this information and an understanding of your financial goals, it’s relatively easy to address 1,000+ point drops long before they happen. Often, the question isn’t about whether these drops in markets will occur, but rather, how much of the drop your portfolio will feel and what your reaction may be in those moments. Will you decided to sell everything and go to cash, will you double-down and buy more, or will you do nothing? We believe utilizing an intuitive risk tolerance assessment is a great starting point towards designing a personalized portfolio that is customized to you and your feelings.

As you plan for your family’s financial future, it can feel daunting to go at it alone. An easy way to address this is by having a trusted friend or partner who you can freely talk to about these personal issues, one you can rely on for accountability when markets drop, and one who goes through the same process as you. In the military, this person is often called a “battle buddy.” If you’re a DIY investor, do you have someone like this that you can rely on?

If not, another way is to hire someone to fulfill this role. An investment advisor with a Fiduciary Duty can not only help you structure your investments for market uncertainty, but also keep you invested when markets drop. It’s easy to hire any financial advisor to implement an investment strategy, but we find that non-investment related issues have a meaningful impact on an investor’s behavior. For these reasons, we believe working with a Fiduciary is the most prudent way to approach your relationship with financial advisors. And that’s precisely why we choose to be Fiduciaries. We’d love nothing more than earning the chance to meet you and learn how we can help make sudden market movements have a more meaningful impact in your life. Here’s how you can get in touch with us.

Where is the Value Premium?

From 1928–2017 the value premium1 in the US had a positive annualized return of approximately 3.5%2. In seven of the last 10 calendar years, however, the value premium in the US has been negative. This has prompted some investors to wonder if such an extended period of underperformance may be cause for concern. But are periods of underperformance in the value premium that unusual? We can look to history to help make sense of this question.

SHORT TERM RESULTS

Exhibit 1 shows yearly observations of the US value premium going back to 1928. We can see the annual arithmetic average for the premium is close to 5%, but in any given year the premium has varied widely, sometimes experiencing extreme positive or negative performance. In fact, there are only a handful of years that were within a 2% range of the annual average—most other years were farther above or below the mean. In the last 10 years alone there have been premium observations that were negative, positive, and in line with the historical average. This data helps illustrate that there is a significant amount of variability around how long it may take a positive value premium to materialize.

Exhibit 1. Yearly Observations of Premiums, Value minus Growth: US Markets, 1928–20173

Value Premium

 

LONG TERM RESULTS

But what about longer-term underperformance? While the current stretch of extended underperformance for the value premium may be disappointing, it is not unprecedented. Exhibit 2 documents 10-year annualized performance periods for the value premium, sorted from lowest to highest by end date (calendar year).

This chart shows us that the best 10-year period for the value premium was from 1941–1950 (at top), while the worst was from 1930–1939 (at bottom). In most cases, we can see that the value premium was positive over a given 10-year period. As the arrow indicates, however, the value premium for the most recent 10 year period (ending in 2017) was negative. To put this in context, the most recent 10 years is one of 13 periods since 1937 that had a negative annualized value premium. Of these, the most recent period of underperformance has been fairly middle-of-the-road in magnitude.

Exhibit 2. Historical Observations of 10-Year Premiums, Value minus Growth:
US Markets 10-Year Periods ending 1937–20174

Value Premium

While there is uncertainty around how long periods of underperformance may last, historically the frequency of a positive value premium has increased over longer time horizons. Exhibit 3 shows the percentage of time that the value premium was positive over different time periods going back to 1926. When the length of time measured increased, the chance of a positive value premium increased. For example, when the time period measured goes from five years to 10 years, the frequency of positive average premiums increased from 75% to 84%.

Exhibit 3. Historical Performance of Premiums over Rolling Periods, July 1926–December 20175

Value Premium

CONCLUSION

What does all of this mean for investors? While a positive value premium is never guaranteed, the premium has historically had a greater chance of being positive the longer the time horizon observed. Even with long-term positive results though, periods of extended underperformance can happen from time to time. Because the value premium has not historically materialized in a steady or predictable fashion, a consistent investment approach that maintains emphasis on value stocks in all market environments may allow investors to more reliably capture the premium over the long run. Additionally, keeping implementation costs low and integrating multiple dimensions of expected stock returns (such as size and profitability) can improve the consistency of expected outperformance. If you are reading this and are not sure what we are discussing, don’t worry; it simply means you haven’t had a chance to sit down with us to explore our Investment Philosophy. We manage clients’ financial lives and portfolios using an academic methodology – one of which is pursuing the value premium. Get in touch today to see how one of our Charleston Financial Advisors can help you.

 


  1. The value premium is the return difference between stocks with low relative prices (value) and stocks with high relative prices (growth).
  2. Computed as the return difference between the Fama/French US Value Research Index and the Fama/French US Growth Research Index. Fama/French indices provided by Ken French.
  3. In US dollars. The one-year relative price premium is computed as the one-year compound return on the Fama/French US Value Research Index minus the one-year compound return on the Fama/French US Growth Research Index. Fama/French indices provided by Ken French. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results.
  4. In US dollars. The 10-year rolling relative price premium is computed as the 10-year annualized compound return on the Fama/French US Value Research Index minus the 10-year annualized compound return on the Fama/French US Growth Research Index. Fama/French indices provided by Ken French. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results.
  5. In US dollars. Based on rolling annualized returns using monthly data. Rolling multiyear periods overlap and are not independent. Fama/French indices provided by Ken French. Indices are not available for direct investment. Their performance does
    not reflect the expenses associated with the management
    of an actual portfolio. Past performance is no guarantee of future results.
  6. Source: Dimensional Fund Advisors, LP with edits by Coastal Wealth Advisors, LLC

 

Tuning Out the Noise

News

For investors, it can be easy to feel overwhelmed by the relentless stream of news about markets.

Being bombarded with data and news headlines presented as impactful to your financial well-being can evoke strong emotional responses from even the most experienced investors. News headlines from the ”lost decade”1 can help illustrate several periods that may have led market participants to question their approach.

  • May 1999: Dow Jones Industrial Average Closes Above 11,000 for the First Time
  • March 2000: Nasdaq Stock Exchange Index Reaches an All-Time High of 5,048
  • April 2000: In Less Than a Month, Nearly a Trillion Dollars of Stock Value Evaporates
  • October 2002: Nasdaq Hits a Bear-Market Low of 1,114
  • September 2005: Home Prices Post Record Gains
  • September 2008: Lehman Files for Bankruptcy, Merrill Is Sold

While these events are now a decade or more behind us, they can still serve as an important reminder for investors today. For many, feelings of elation or despair can accompany news headlines like these. We should remember that markets can be volatile and recognize that, in the moment, doing nothing may feel paralyzing. Throughout these ups and downs, however, if one had hypothetically invested $10,000 in US stocks in May 1999 and stayed invested, that investment would be worth approximately $28,000 today.2

News
Exhibit 1. Hypothetical Growth of Wealth in the S&P 500 Index, May 1999-March 2018. © 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Not representative of an actual investment. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.

When faced with short-term noise, it is easy to lose sight of the potential long-term benefits of staying invested. While no one has a crystal ball, adopting a long-term perspective can help change how investors view market volatility and help them look beyond news headlines.

THE VALUE OF A TRUSTED FINANCIAL ADVISOR

Part of being able to avoid giving in to emotion during periods of uncertainty is having an appropriate asset allocation that is aligned with an investor’s willingness and ability to bear risk. Take our free risk assessment here. It also helps to remember that if returns were guaranteed, you would not expect to earn a premium. Creating a portfolio investors are comfortable with, understanding that uncertainty is a part of investing, and sticking to a plan may ultimately lead to a better investment experience.

However, as with many aspects of life, we can all benefit from a bit of help in reaching our goals. The best athletes in the world work closely with a coach to increase their odds of winning, and many successful professionals rely on the assistance of a mentor or career coach to help them manage the obstacles that arise during a career. Why? They understand that the wisdom of an experienced professional, combined with the discipline to forge ahead during challenging times, can keep them on the right track. The right financial advisor can play this vital role for an investor. A financial advisor can provide the expertise, perspective, and encouragement to keep you focused on your destination and in your seat when it matters most. A recent survey conducted by Dimensional Fund Advisors found that, along with progress towards their goals, investors place a high value on the sense of security they receive from their relationship with a financial advisor.

News
Exhibit 2. How Do You Primarily Measure the Value Received from Your Advisor? Source: Dimensional Fund Advisors. The firm surveyed almost 19,000 investors globally to help advisors who work with Dimensional better understand what is important to their clients.

Having a strong relationship with an advisor can help you be better prepared to live your life through the ups and downs of the market. That’s the value of discipline, perspective, and calm.

 

At Coastal Wealth Advisors, we believe that the right financial advisor plays a vital role in helping you understand what you can control while providing the expertise, perspective, and encouragement to keep you focused on your destination. That’s the difference the right financial advisor makes. If you find yourself more worried now than you have been in the past, give us a call; we’d love to sit down with you and learn about your unique life.

 


  1. For the US stock market, this is generally understood as the period inclusive of 1999 – 2009.
  2. As measured by the S&P 500 Index, May 1999–March 2018. A hypothetical dollar invested on May 1, 1999, and tracking the S&P 500 Index, would have grown to $2.84 on March 31, 2018. However, performance of a hypothetical investment does not reflect transaction costs, taxes, or returns that any investor actually attained and may not reflect the true costs, including management fees, of an actual portfolio. Changes in any assumption may have a material impact on the hypothetical returns presented. It is not possible to invest directly in an index.
  3. Source: Dimensional Fund Advisors LP with edits by Coastal Wealth Advisors, LLC.