ETF Edge - The SPAC Space & Free Cash Flow vs. Earnings

Episode Date: January 25, 2021

CNBC's Bob Pisani spoke with Mark Yusko, CEO of Morgan Creek Asset Management, Bob Shea, CEO of TrimTabs Asset Management, and Ben Johnson, Director of Global ETF Research at Morningstar. They discussed the SPAC craze as the third SPAC ETF gears up to launch tomorrow – this time an actively managed one. Is there a bubble brewing in the SPAC space? And what’s the broader outlook for active management vs. passive in 2021? In the 'markets 102' portion of the podcast, Bob continues the conversation with Mark Yusko of Morgan Creek Asset Management. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge podcast is sponsored by InvescoQQQQ, supporting the innovators changing the world. Investco Distributors, Inc. Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange, traded funds, you are in the right place. Every week, we're bringing you interviews and market analysis and breaking down. What it all means for investors, I'm your host, Bob Pisani. Today will delve deeper into the SPAC craze as the third SPACETF gears up to launch. This time an action.

actively managed one? Is it a bubble brewing in the SPAC space? And what's the broader outlook for active management versus passive in 2021? Here's my conversation with Mark Yusco. He's the CEO of Morgan Creek asset management. Bob Shea is the CEO of TrimTabs asset management. And Ben Johnson is the director of global ETF research at Morningstar. Bob, I want to start with you. There's a lot of craziness in the markets today. We were just talking about it on air. You were the head of Goldman Sachs' equity desk for 14 or 15 years. You've seen a lot of craziness yourself here. We saw today Apple getting thrown around like a rag doll. It was 136 to 145 at an hour for the biggest company in the world. Game stock goes, game stop goes parabolic, then all the way back down, halted a

numerous times throughout the day. What do you think is going on here? There seems to be a little bit of a market issue with concerns about the COVID vaccine narrative changing a little bit. Some concerns, maybe the stimulus program is not as certain or not as big as people think. And other people are saying there's a sideshow going on with people trying to play the lower price stocks and the stocks that have been heavily shorted. Can you spend a minute and just sort this out for us? Yeah, terrific. Thank you. First, thanks. Thanks for having me, Bob. And yeah, you know, I, I ran Goldman's equity trading desk. Well, my desk was cable out of the dot com.

There have been a lot of people writing and talking about the similarities between them and now. And there are definitely some similarities, but there are some big differences in the environment. Kind of the action or sanctivity that's more based on positioning, options, positioning, and shorter-term, euphoric kind of sense. And we're seeing that bubbling up. Obviously, we have money supply, which is, you know, on the one hand, you know, there are some similarities. On the other hand, there's some completely... Yeah, I guess, and feel free to jump in, Ben or Mark, but the similarity that I see is people are still reacting to the same euphoria.

This manias still happen. That dopamine rush to people still get in their heads that we saw so notably in 1999 when you were around Bob, and I was reporting on this as well, hasn't changed. A whole field of behavioral economics came out of a lot of this studying how people react to euphoria and to manias and how people react to bubbles in general. So that certainly sounds very similar to me. What's different is the technology is very different. You know, when people opened their DLJ accounts at 1998, it was pretty cumbersome. You could get a confirmation. It would take 20 minutes to the next day. Today, you're sitting in a bar with your boyfriend or girlfriend and your Robin Hood account,

and you trade stocks like you're on Fanduil, like a sports game almost. It has similarities. Isn't that the difference here this time? It's a lot easier to do this. If you remember for the IPOs where we did price something at 30, kind of a one-sided options positioning, where perhaps some of the, you earlier, are using leveraged options plays to express bullish views in a lot of these stocks

and a lot of, you know, kind of the NASDAQ. Backdrop, very different. What's very different, you know, we focus on free cash flow. I just tell you that 21 is very different, you know, from the 100 that is positive. It's free cash flow margins and free cash flow yield, just much, much healthier. Now, does that mean we, we,

towards the end? into the 2000, into 2001, and they just don't exist with regard to divergences. What we have in it is, and on the one hand, and we're seeing in the last few years. Yeah, that sounds right to me. Mark, I want to talk to you about SPACs, but I wonder if you can react to what Bob was saying there. I think he brings up a good point. There's obviously the start of a long-term recovery, and yet there's, today it feels like a blow-off top, kind of, in a way. I know we're supposed to talk about SPACs here, but any thoughts about what's happening right now?

No, we can definitely get to SPACS, but definitely have a reaction in that, you know, the gamification, I think it's interesting that we're talking about GameStop all morning in a world where investing has truly become gamified. People were in lockdown. They couldn't bet on sports because sports wasn't happening. And suddenly, Draft Kings and others got people's attention focused on the market. I do think we're at a speculative peak. I do think this could be, we don't know, but it could be that event, that, that seminal event that triggers some motion downward. But it is pretty wild, Bob, you're right.

Yeah, Ben, your thoughts, you're an old hand. You've been watching the markets for many, many years as well. How does this kind of, is it a blow off top in your opinion right now, or is something else going on? and how does it affect the world of ETFs? Yeah, Bob, I think the key term that they market on is gamification in what might be different today versus what we saw in 2000 is exactly what you've described, the fact that I can walk around with a supercomputer in my hand,

make trades and make options trades all day, every day, in some cases, maybe allocating capital that arrived to me via a stimulus check into the markets and see a little animated, fetti dropout anytime I make some money in the market, that I think is only played on and really exacerbated all of those animal spirits, all of the worst of our behavioral biases that go around. And I think it's gotten to the point where many professionals, many people watching

the market, myself included, has gotten to the point where we're wondering, are we the crazy ones in all of this? Are we missing something that all these other people aren't? And usually that's when you can't ring a bell at the top. It's probably a good time to start ringing it close enough to the top. Yeah, we are, no, you're not crazy. And the answer to all of this is we have seen this before. And I feel like launching into, you know, behavioral economics 101,

but we don't have the time to do that. But this was all very well studied over the last beginning about 1980 by people. like Robert Schiller and other people like that and won Nobel Prizes for what's going on here. But I want to move on here. Let's talk about SPACs a little bit because, Mark, I've got you on specifically. You've got a SPAC ETF coming this week. I think it's the third one. This is actively managed now. We talked on the air about this a little, but what impresses me about this is two-thirds of the companies that you're picking will come from companies that have already chosen a partner, one-third from companies that are still seeking startups. What's amazing me is how you make the decision on active management in this kind of environment

and picking a company that hasn't even done a target yet. How would you even decide that? Tell us about this, how you're picking this. Yeah, look, at the end of the day, you know, it's about the people, Bob. People and management teams, the great ones tend to win. And so, you know, the nice thing is ourselves and Exos, our partner, We've been doing this collectively for five decades. We've been partnering with management teams.

We've been picking the winners from the losers. And I think the big opportunity here is to take this superior structure, which is if you're a high-growth company of the future, right, a company that has really big upside and doesn't want the hassle of the traditional IPO process, doesn't want to be encumbered by not having the ability to make forward-looking statements, You have this wonderful innovation in SPAC structure that allows these companies to get public. And therefore, the great management teams, the ones that you want to partner with for decades to come, become pretty readily available for investors and pretty apparent to professional investors like ourselves.

So we're excited to bring this active approach to a market that I think is really in its infancy. I mean, I said, you know, when we were talking last week, that, you know, 2020 probably goes down as the year of the SPAC, right? More SPACs were issued, more dollars were raised. And there are those that want to call it a bubble. But it's not a bubble. I mean, a SPAC is a legal structure. It's like mutual fund or ETF. And the people that criticize SPACs today are the same ones that criticize hedge funds 10 years ago or criticized mutual funds 30 years ago.

So when lots of people like a structure and people have success utilizing it, other people may not like that. So we're very excited about the opportunity, very excited about the market. And you bring up the most important point, and we've been talking about it with the craziness of the markets. The average investor has to navigate extreme valuations, extreme attraction of these markets for unsavory types to bring companies public. And by focusing on quality, focusing on the best teams and the best ideas and the best companies, I think you can get great returns.

Yeah. Focus on quality is all well and good, but it's a pretty confusing universe out there. I want to open this up to Ben and Bob's comments, but I want to first run a comment on the explosion in SPACs from former Goldman's CEO Lloyd Blankfein. He was on this morning talking about exactly this. Let's run the bite and we'll chat on the other side. If a few of these go bad or they were overpaid and some people made a lot of money and investors lost money, people are going to say where, you know, you achieve the economic equivalence of an IPO, but where was the process and diligence that we all associated with a rigorous IPO diligence process? And that kind of drops out. Now, I'm not saying that they're all bad or that any of the ones that you could bring up

are bad bad. Some of these won't work. And my advice to people who are doing this now would be really, really diligence, really, really documents. But, you know, again, in hindsight, if something goes bad down the road, people will look back and, you know, show trials to follow. Yeah, exactly. So, Ben, let me get your take on this. We're going to now have three SPAC IETFs out there. But I think the relevant line here from Lloyd is we have the economic equivalence of an IPO, But where was the process and the due diligence that we see with the rigorous IPO process? Is that a fair comment from Lloyd Blankfine about the whole SPAC explosion? Yeah, I think it's a fair comment, and I would argue that it's more so a functional equivalent of an IPO from an issuer's point of view.

From an economic point of view, and the investors' point of view, most importantly, I think an IPO that effectively shifts more of the risk and potentially, less of the return onto investors, that investors in this case and the majority of these cases will be the ones that wind up being the bagholders. You know, looking at research produced off the desks of my colleagues at Pitchbook, they see this as a fleeting phase as a means of raising capital that speaks to the moment that we're in and the difficulty that a lot of these firms would have going through the traditional IPO process, they expect that it'll come and go. And if you look at really the economic equivalent in terms of stocks that are already out there on the marketplace, be they stocks that came to market

through the IPO or stocks that are simply smaller and have greater growth prospects, I look back at the performance of the oldest SPAC-E-F, SPA-K, is the ticker there, which has only got a few months' worth of track record under its belt. And its performance has been half that. of the Vanguard small-cap growth ETF over the course of the past few months. And it's been half that of the First Trust U.S. equity opportunities ETF, which invests in traditional IPOs. FPX is the ticker there. So investors have to ask themselves whether it makes sense to arbitrarily limit their investment

opportunity set to a handful of names that are coming to the market through a very novel means. than one, again, that probably is disfavorable from an investor's point of view because there's a lot of value that accrues to the end investor through that normal IPO process, a very thorough vetting by many pairs of very well-trained, very detail-oriented eyeballs that are going to try to assess how much that thing is going to actually be worse at the end of the day. I just want to vehemently disagree there. You know, what's interesting is a SPAC,

IPO is an IPO. It has been vetted. It is even taken public by many of the same firms that Mr. Blankfine refers to. You know, it's typical commentary from an incumbent, right? Spax took up over a quarter of IPOs last year. That means less business for the incumbent, so it's not shocking that they would criticize. The idea that this is bad for investors is simply not true. The average IPO, the average investor can't participate. Those IPO shares are allocated to the big fat cat clients of the big Wall Street brokerage firms, not to the average investor. A SPAC IPO, because it goes public at a $10 price, is available to everybody. And since you don't know what the deal's going to be, you don't have the speculative frenzy on the day one of trading. So you can actually acquire a

position, then when the deal's announced, again, by quality management teams of quality growth businesses, you've seen outstanding performance. So the last couple of months, not really relevant in performance terms, look over the last year, look at a basket of SPACs more than double the return of the S&P. It's a fantastic structure. It's changed over the last 30 years. It's nowhere close to what it was in the early days in the 70s and 80s. And it actually is a boon to the average investor. But there must, I think Ben's point is there must be a reason why suddenly SPACs have exploded so much. There is an advantage to the process for the people that are using the SPAC SPAC system. I think what Ben is expressing is some concern about that process. Are we going to be

down the road six months from now saying, you know, the SPAC boom has gone busts because so many SPACs came public that were, some would say, and Blankfine was implying, not necessarily ready to come to market. Is that a fair observation? Again, I don't think it is by and large. I think as you and I discussed on Friday, of course there will be people and management teams and sponsors drawn to this structure that shouldn't, and those will have bad outcome. But as every IP a good outcome, not even close, despite the rigorous betting. Because at the end of the day, Wall Street gets paid to take companies public. So they're going to take companies public.

Like Doritos commercial, go ahead and eat them, we'll make more. And so at the end of the day, look at the companies that have gone public using the SPAC IPO. And you asked Bob, what's changed? What changed really was Chimoth and Virgin Galactic, where really, really, really, robust companies of the future, these companies in electric vehicles, in video gaming and e-sports and e-commerce and space travel, these companies that if you had to have five years of profit, if you could only make commentary on historical revenues and cash flows, you wouldn't be able to do a roadshow and tell your story. What the SPAC structure allows is open-ended

commentary about future story. And it gives these high growth, great businesses, a platform to, I think, bring what had been private businesses, the opportunity to be invested in by the individual investor, which is fantastic. Yeah. I want to talk to you more about that in the podcast. I'm at Chimoth and how it changed the business. But I want to move on a little bit and talk with Bob about active management. And Bob, this is a slightly different story. but you run an actively managed fund in TrimTabs, the all-cap U.S. free cash flow ETF. And you have been investing,

and really, TrimTabs is all about free cash flow as the key metric. Can you very briefly just tell us why is that the most important thing to you? Is it even more important than actual earnings? Yeah, as you know, management has great latitude and discredability, which is the focus of our investment strategies. And our research shows that free cash flow profitability, just property, excuse me, other popular quality indicators like return on equity and return on assets,

gross margins, earnings per cent, you know, and nothing gets into our. Yeah, so essentially you're applying free cash flow. It's harder to futz around with free cash flow than it is with the, with earnings. And it's a pure, a pure look at how companies are doing. Is that the point? And we have decades of research that support that. Now, when I look at this, It looks like a high quality fund. So I'm looking at the top holdings here. J.P. Morgan, Apple, Morgan Stanley, Microsoft, and Amazon here. It kind of looks like a high quality fund.

What's the criteria for inclusion here? Is it just cash flow? And in the case of the big financials in there, there is a tilt as banks are not typically measured on free cash flow, however, restraints where they were when these went in. Okay, going to have to leave it there. guys, very fascinating conversations. Now it's time to round out the conversation with some analysis

and perspective to help you better understand ETFs. This is our Markets 102 portion of the podcast. Today we'll be continuing the conversation with Mark Yusko of Morgan Creek Asset Management. Mark, thanks very much for staying with us. I just wanted to ask a couple more questions on the whole SPAC ETF and the SPAC space in general. Can you, one of the things that I see a lot here with these SPACs is fairly high expense ratios. Obviously, there's a lot of trading going on here. What's the expense ratio for this SPAC ETF that you're launching? Yeah, 1%.

1%. That's high compared to most ETFs. One of the concerns here is that you may have a fairly high portfolio turnover rate. Maybe that'll lead to higher trading costs, capital gains distributions. Is that an issue for investors in this kind of situation? Yeah, I think, as you and I have talked, about last week, one of the things is active versus passive comparisons. Active management historically has a higher expense ratio than passive management.

And there's even the race to zero on the passive side, so basically no fees, and they just sell your information to the big high-frequency traders. So we believe that this space in particular, active management is really key, and therefore where you want to have a professional team. And so we're going to have some higher expenses between ourselves and Exos to cover there. In terms of a lot of trading and capital gains, one of the nice things about the SPAC structure

is particularly for the piece where you're buying free announcement, the deal announcement window is about 12 to 24 months. So in many cases, by the time the deal's announced, you're going to have long-term capital gains as opposed to short-term. And in most of the cases, post-merger announcement, we're buying into companies that we actually want to hold for many, many years, right? We believe these are the companies of the future.

And so it's the work before you do the buy that takes this kind of value discipline that, you know, I come, that's my background. And Exos comes from the trading and market-making background. And together, I think we're going to have a very solid portfolio that I think ultimately could be quite tax-effective. efficient as well. Yeah. You mentioned, though, a little while ago while we were discussing it in the show, that the sort of big moment for SPACS came with Chimoth Pala Hippatia and the success he had with his first SPACs that were out there. Virgin Calactic did very well itself.

And yet, prior to that, SPACs weren't very highly thought of. They were largely used by small cap companies. They didn't have very good track records overall. So you had an event here, a specific event that helped put SPACs on the map. And one of you that address the sort of criticisms here that I constantly get from people who say, you know what, Bob, this is not as a rigorous way to go public. There is less disclosure. They are allowed to make forward-looking statements that IPOs are not.

And some people are not so sure that that's the right thing to do at all. How do you address that particular line of criticism? That it's not just that it's a better mechanism for going forward. It's just an easier mechanism to get yourself public. Look, it's a great thought that if it were true, that there was lower levels of scrutiny and really lower levels of regulation that it would be something you'd want to avoid. What's interesting is it's a historical change or an evolution. You know, 30 years ago, 35 years ago, when the...

SPAC structure really came into vogue. You're absolutely right, Bob. It was a less preferred way of going public, and it was kind of for the leftovers, those that got rejected in their bid to go public. And most of the SPACs were done by industrial companies, which had very poor prospects, and financial sellers that were just unloading on unwitting public investors. There was a big change in 2015 with the actual structure around SPACs. that basically prohibited a lot of the shenanigans that went on before. Now, why did it take three years between, you know, the change in the regulations in Chamath? Just people weren't really sure if these were going to stick and if it was really going to become a legitimate means to going public for real businesses.

And I think what you've seen, and it's not just, you know, Virgin Galactic, there's draft kings and and myriad other really impressive companies run by impressive management teams that have found that, one, it's less costly to do a SPAC than traditional IPO. Two, for a high-growth company of the future, you really do have this advantage in that, you know, I don't have to have profits. I don't have to have history. I can tell you my story. And where I get the most excited about is I've been a investor in the private markets for, you know, three decades. And one of the things that happened over the last decade is those private companies were staying private longer and all that wealth was accruing to, you know, wealthy individuals who were accredited investors and who could invest in those private partnerships. This allows some of those

companies to come public and get those stocks in the hands of traditional investors. But that's some of the, what you just said is some of the reasons people bring up as a warning signs. I don't have to have profits. I don't have to have a long history. No need for to announce 10 years of prior profits or anything like that, that's part of the reason people are concerned about this. I also see signs of, you know, euphoria here. I mean, it's one thing for a company that's an operating company to try to go public, but what do you think when we have suddenly, we've got former congressmen, authors, or actors or sports figures announcing they want to do a SPAC. Doesn't this raise a little bit of a red flag with you? A hundred percent, Bob. I could not agree more. And it's pretty

precisely why the Morgan Creek Exos ETF is active. We completely agree that the best will always be attracted to a superior structure, whether it's the best venture capitalists or the best growth equity providers, the best mezzanine debt financiers, the best companies will get the first opportunities. And then if a structure is successful, the less palatable players. will show up. And we agree completely that you want to avoid the real, you know, pretenders. And for us, that's why active management is so critical here. If you can avoid the losers, right, we know they're going to be winners. We know they're going to be losers. Not all SPACs are

going to be great, just like not all stocks or not all IPOs are great. But if you can avoid the losers, the gains will take care of themselves. Spax accounted for almost half of all the money raised last year. It was something like $160 billion, and Spax were something like $80 billion. Do you think we could have a similar number this year, or do you think Spax would do better? I mean, how, Spax versus traditional IPOs, how do you think the money will come down? Look, I think two things are going to happen. And Bill Gurley wrote a great blog post in his above the crowd on this. And he said, look, there are three options to go public, right? There's traditional IPO.

There's direct listing, right? Just a Dutch auction. And then there's SPACs. And what he said, and what I agree with, and hence the reason we're launching this ETF, is that we think SPACs are going to become the preferred method for these really superior high growth, you know, institutions or, I should say, industries of the future. And that's why you do see a predominance of technology companies, advantage. And those are the businesses that you want to own. You know, look how great

Fang has done over the last decade. Look how great technology IPOs have been. We think those companies, because they have better control, more flexibility, and lower cost are going to migrate to SPACs. And we think the future is bright. So I do think there'll be a higher percentage this year and a lot of winners. When is the SPAC-ETF going to start trading? We launched tomorrow Tuesday. X Z is the ticker and really excited and really excited to talk to you about that on the Eve before. I feel like a kid at Christmas Eve.

We'll have you back. Again, this is a hot investor topic. A lot of good reasons to be exciting. A lot of reasons to be cautious, but you've heard about my caution and you've answered all those questions. Mark Yosko, thank you very much for joining us. Mark is the CEO of Morgan Creek Capital Management. Of course, you're listening to the ETF Edge podcast. Everybody has a healthy, happy, and safe trading with you.

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