How Did They Do? - Revisiting Carbon, SPACs, Silver, Convertible Bonds, and Frontier Markets
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I'm your host, David Stein. Today is episode 436. It's titled, How Do They Do? Revisiting Carbon, SPACs, Silver, Convertible Bonds, and Frontier Markets. We cover a wide variety of asset types on Money for the Rest of Us. And I think it's helpful to go back and review those asset types to both make sure we remain familiar with them, but also to see how they have performed since we

We last covered them. Now, the assets I mentioned, carbon, SPACs, silver, convertible bonds, and frontier markets, they're very different. One, I think it's a terrible investment. That would be SPACs. Two are speculations, silver and carbon. Convertible bonds and frontier markets, I would consider investments because they have a positive expected return.

because of the underlying cash flow associated with those two investments. Now, that doesn't mean performance has been great since we covered them. But let's get started with what I think is the worst investment. We covered it back in October 2020. It's Special Purpose Acquisition Companies, or SPACs.

These are non-operating, publicly listed companies whose purpose is to identify and purchase a private company. And that allows the acquisition company to have publicly listed stocks. SPACs are sometimes known as blank check companies. And when a SPAC buys one of these private companies, it's called a reverse merger because it's opposite a typical merger. A public company is taken private

With a SPAC, it takes a private company and makes it public without having to go through all the burdensome procedures through a traditional initial public offering. SPACs are also attractive to the founders of these private companies because they can sell a higher percentage of their ownership in a reverse merger. Now, there are some things about SPACs that are unfortunate. Why?

One is that the sponsors of the SPAC basically get 20% of the company for free. And they get what are known as Class B founder shares and warrants. So they're basically able to purchase up to 20% of the outstanding shares at incredibly inexpensive rates. And that really leads to some conflicts. A SPAC has two years to find an acquisition target.

The founders of SPACs, knowing that they have the potential to significantly increase their net worth, if they find an acquisition target and close the deal because they get 20% of the company, which they can then sell, they have an incentive to go find a company, even if it may not be the best deal for the SPAC shareholders. And by and large, investing in SPACs has not been a great deal for shareholders.

Before we turn to performance, how this works then, the SPACs have two years to identify an acquisition target. If they can't find one within two years, if they're not given an extension, they have to return the money. So the money raised in the IPO for a SPAC is kept in an escrow account. So the vast majority, upwards of 90%, is in this escrow account, essentially earning cash yields. After an acquisition is noted, it's announced,

There's additional due diligence, negotiation, and then the SPAC has to raise additional funds, either equity or debt, to complete the combination if it's approved by the shareholders. If more than 50% of the SPAC shareholders disapprove of the business combination, then the escrow account is closed and the proceeds are returned to the shareholders.

When we did that episode back in 2020, SPACs were incredibly hot. There was a lot of press on them. A lot of individual investors were piling into SPACs. But we warned at the time that performance had not been great. And that continued to be the case. This is

some data from Jay Ritter, who's a professor of finance at the University of Florida. He shows that the average three-year return for SPACs, and these are SPACs that had IPOs in 2012 through 2022, the average three-year return after an acquisition has taken place, what is known as being essentially de-SPACs, because once they do an acquisition and the new stock is there, the

the combination of the SPAC and the private company, the average three-year return has been negative 57%, not been a great deal. We discussed a number of ETFs at the time. One was the Defiance Next Gen SPAC ETF, SPAK, SPAC.

SPACs have performed so poorly over the past two years that it closed in October 2022. At one point, it had $112 million, but from investor outflows and just the collapse in the SPAC market, there was $16 million. Another ETF we discussed, one that I held for about a year, is the SPAC and New Issue ETF, SPCX. It invests in new SPACs that just had an IPO and then typically will sell once the

the acquisition announced, so hopefully not getting caught with the big drawdown, that still operates. So the return of SPAC, since that episode aired in October 2020 through earlier this week, June 2023, the SPAC and new issue ETF SPCX has returned negative 1.7% annualized. That compares to 4.5% for the Vanguard Total World Stock Market ETF VT.

Depending on what SPAC an investor owned, they could have done much worse or surprisingly much better. I found one index, which I found fascinating. The S&P US SPAC index will hold up to 30 SPACs, but currently has about 70. It lost money in 2021, down 2%. It was down 18% in 2022, but it gained 250% in 2020. And I don't know what particular SPAC it owned,

But that huge bump in 2020 allows the three-year return for this particular SPAC index to be 26% annualized and the five-year to be 23% annualized. I would say most SPAC investors didn't experience anything like that. I went a year from the end of 2020 through the end of 2021 buying individual SPACs that were

newly issued that I thought would make an announcement and then perhaps their stock price would jump, I broke even. And so SPACs, by and large, because I believe the incentives are misaligned where the founders of the SPAC have an incentive to find an acquisition because they get 20% of the company for free, then they can dump the shares, that it just is not a great investment and that has shown up in the performance.

The next asset class we discussed was in December 2020, episode 325 on convertible bonds. Convertible bonds are debt securities issued by corporations that include an option for the holder to convert the bond into shares of the common stock. So they have a bond or fixed income like element, and then there's a stock like element. And so the combination of returns is getting the yield from the interest on the bond

but then the upside of converting the bond into a stock if a particular price threshold is met. When we did that episode in December 2020, convertible bonds had done very well, but it was an unusual time because traditionally there's been a lot of tech-oriented companies that issue convertible bonds. And two of the biggest issues outstanding in December 2020 were by Tesla.

and Tesla stock had done incredibly well coming out of the pandemic. And as a result, those Tesla convertible bonds made up more than 10% of the index, and the returns driven by the stock price of Tesla led to 30% to 40% gain or positive return for convertible bonds in that 2020 period. But then...

When the stock sold off and then we saw the downside to that, but it was in an unusual period. Ideally, when we think about convertible bonds, when we're modeling the expected return, we take the current yield to maturity, which is around 4.3% to 4.5% right now. And then we assume the delta, basically how much of the stock market upside and downside returns

accrues to the convertible bond return. And it's typically been about 50% of the stock market's upside or downside. So if we assume an expected return of stocks over the next decade of 7.5% or 8% or so, then an expected return for convertible bonds would be the current yield to maturity, which is around 4.3%, plus roughly 3.75% to 4% for

for the stock component for a combined return of around 8%. Companies like to issue convertible bonds because interest rates are typically lower than on non-convertible bonds, and it's a way to raise capital without diluting the existing common stock shareholders because it's only if the stock price goes up are the convertible bondholders allowed to convert it in

into stock. Now about 1% of convertible bonds default each year, but this is an asset class that I like. And I have invested in the past. I haven't invested recently, but I'll certainly continue to look at it, especially with that 8% expected return. If we look at then how convertible bonds have done, one method to invest is ETFs. And I think that's a good way of going about it.

The iShares Convertible Bond ETF, ICVT, from December 15, 2020, when the Convertible Bond episode was released, through June 12, 2023, it returned negative 5.1% annualized. That compares the negative 5.2% to the Vanguard Total Bond Market ETF, BND. We've been in a period of rising interest rates and

And convertible bonds are interest rate sensitive like regular bonds, but not so much as regular bonds. So they tend to not go up and down as much as regular bonds because of the equity component of convertible bonds. But with the equity market selling off, and particularly with Tesla selling off initially before their bonds were converted, that put some downward pressure on convertible bonds. But as I pointed out, now the expected return

is 8% for convertible bonds versus Vanguard Total Bond Market ETF. Its current yield to maturity or SEC yields about 4.2%. So convertible bonds have some upside potential compared to regular bonds, and that's why I like them.

The next asset class then is silver. In episode 330, Is Silver the Next Game Stop?, we looked at how to invest in silver. That was released in February 3rd, 2021. It was around the time that silver had spiked and it was at its highest level in eight years at $27 per ounce. There was a lot of interest on Reddit and other sites.

stock forums, and we looked at the two primary ways to invest in silver. The simplest is through an ETF, an exchange-traded fund, like the iShares Silver Trust, SLV, that owns physical silver, either in bullion bars, which would typically be how an ETF could do it, or an individual could buy silver coins. The other way is to invest in silver futures, which

is a little more complex. A silver future or any type of futures contract is an agreement to buy or sell a particular commodity at a future date. So an investor that wants to go long silver will enter into a contract. And let's say that the silver contract is six months from now, that's when it expires and it's priced at $27 per ounce for silver.

The current price for silver right now, bought price is $24.30 an ounce. And so an investor that goes long, silver in that six-month contract, in order to make money, the silver price would need to go above $27 per ounce. And then the future contract could be reversed and lock in the gain. If the silver price goes down, then the speculator in silver will lose money. However, there's always someone on the other side of the trade, somebody...

That is shorting silver, expecting it to go down. And then there's a commodity exchange that acts as the intermediary.

Silver differs from gold in that more silver is used for industrial uses in making things. There's about 800 million ounces of silver coming out of silver mines each year, and then there's another 200 million that's recycled. And about half of that 500 million ounces is for industrial uses, including some silver that can be used in solar panels. And then there's demand, about 200 million ounces per year for jewelry, and then there's

And then there's the speculation element, such as silver that's held in ETFs that own the silver bullion.

A few episodes ago, we looked at the bullish case for gold, and the primary demand for gold isn't from industrial uses. It's people holding it as a store of value. There's a small amount for jewelry, but mostly it's speculators, including individual investors, could be institutional investors, and central banks. Silver is different, though, because there is that element of industrial use. I prefer gold and I hold gold, but

There are people that prefer silver because it can be bought in smaller increments, $24.30 per ounce, compared to close to $2,000 an ounce for gold.

If we look then at the return of silver since that episode, the iShares Silver Trust has returned negative 5% annualized from February 3rd, 2021 through June 12th, 2023. That compares to 2.4% annualized for the Spider Gold shares, GLD. So gold has actually outperformed silver since February 2021.

The Vanguard Total World Stock Market ETF, VT, was down 2.2% annualized from February 2021 through June 12, 2023. So gold outperformed the stock market and outperformed silver. Silver lagged the stock market. Now, the iShares Silver Trust, it owns silver bullion. If an investor was an aggressive speculator, they could have used an ETF that invests in

Silver futures, in fact, the ProShares UltraSilver ETF, AGQ, seeks to deliver twice the daily performance of the Bloomberg Silver Subindex. So this is a leveraged, aggressive play on silver, and it returned close to negative 20% annualized since February 3rd, 2021 through June 12th,

2023. So silver, not so great, better than SPACs, and about the same as convertible bonds. Before we continue, let me pause and share some words from this week's sponsors. I bought a used denim coat from a reseller, Odyssey Rebuild. I'd never heard of them. They came across my Instagram feed. But I took the leap. I bought the coat. And once I saw the reseller was using Shopify, I felt a lot more confident in my purchase.

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Let's turn then to frontier markets. This was episode 347. We released it June 22nd, 2021. Frontier markets consist of equity markets or stock markets of countries that are in the early stages of economic development. Typically, they're less liquid and they might have some restrictions on the ability of foreign investors to access those countries. The MSCI is a leading provider of indexes and they

divide the world stock market into developed markets, which would include the U.S., Canada, countries in Europe, Japan, Australia. Emerging markets, which are still developing, can include countries like Mexico and China. And then there are frontier markets. Frontier markets are those that are in a much earlier stage of development, or at least access to the market compared to emerging markets. And then separately, there's standalone markets that

that MSCI just isn't comfortable including in an index because they have major issues. The MSCI Frontiers Market Index is comprised of about 100 stocks from around 28 frontier market countries. And the biggest frontier market in that index and in ETFs that follow them is Vietnam, makes up about 30%. But other examples of frontier markets is Romania, Kazakhstan, Philippines, Peru, Colombia, Morocco, Egypt, Nigeria,

So it is diversified, about 100 stocks. And the idea of investing in frontier markets, given they're going to be potentially more volatile, but to participate in that country's growth over time, assuming the political investings

Environment becomes favorable to innovation and that overall household wealth increases over time, the incomes increase, and it pushes up the earnings of those frontier market companies together with an attractive dividend yield leads to positive expected return.

If we look at the performance of Frontier Markets, they didn't do so well since we released that episode in June 2021. So it's been just about two years. And the annualized return for the iShares Frontier and Select Emerging Markets ETF is negative 18% annualized compared to negative 3.3% annualized for the Vanguard Total World Stock Market ETF.

The biggest driver of that poor performance is that frontier markets have

have gotten much less expensive. When we released the episode, the price-to-earnings ratio, what investors were willing to pay for essentially dollars worth of frontier market exposure was 18.2, and the dividend yield was 2.7%. Now the price-to-earnings ratio is 10.4, and the dividend yield is 4.7%. That means frontier markets now have a much higher expected return than they did 10.5.

two years ago. If we assume a dividend yield of 4.7% and we assume that earners

earnings growth is around 2.7%, and that the valuation, the price-to-earnings ratio of frontier markets returns to its average, so it's 10.4% now, the long-term average is 12.8%. If they return to that higher P.E., that would equate to a 9.5% annualized return for frontier markets over the next decade.

There are definitely some caveats there, whether earnings growth would actually come in at 3%. If we look at earnings growth over the past decade, it's been 2.7% annualized for frontier markets. But for the 10-year period ending June 2021, frontier markets only had around a 1% annual earnings growth. So if earnings growth is only 1%, given the attractive dividend yield, that's still close to...

a 6% return, assuming valuations stay at 10.4% and that frontier markets currencies don't weaken. They definitely weakened over the past 10 years, and that led to also about a 3% drag for frontier markets. But it is a way to play equities. Certainly, the countries that are developing and right now the valuations are

are attractive. As I mentioned, the average, the current dividend yields 4.7%. The average going back to 2008 is 4.1%. And again, the current price-to-earnings ratio is 10.4%. And the average going back to 2008 is 12.8%. So there is higher expected returns now for frontier markets compared to when we did the initial episode in June 2021.

Finally, let's look at the best performing investment that we're covering in today's episode, carbon. This was episode 351, released July 27th, 2021. Carbon is a broad term to describe carbon dioxide and other greenhouse gas emissions whose buildup in the atmosphere over many, many decades. The science behind carbon

Climate change has been known since the late 19th century, how these greenhouse gases build up and it leads to warming in the atmosphere. As countries come to agreement on how to reduce the amount of carbon and other greenhouse gases being released to the atmosphere, one of the things they've come up with are caps or a limit to how much a company can release in terms of carbon. At the same time, they've developed a

emissions trading systems, which essentially trade carbon allowances. So the European Union, for example, has the ETS, the emissions trading system. They allow a certain amount of these carbon credits that companies can purchase if they want to go above their emissions mandate. And

And so these carbon credits trade in a market. There's a futures market for it. And these, they work just like any other futures market, like the silver futures market that we've talked about. An investor could buy what's known as the EUA. It's a carbon credit on the European emissions trading system. Right now, the EUA is priced at 88 euros back in

In 2021, when we did the episode, it was 60 euros. And so you can imagine now, if we're at 88 euros per EUA and it was at 60, that this has been a good investment.

One way to invest in that would have been the Crane Shares Global Carbon ETF, KRBN. And since July 2021, it's returned 17.3% annualized compared to negative 4% annualized for the Vanguard Total World Stock Market ETF. KRBN has about 56% of its assets in European Union allowances, these EUAs, and then 30% or

or more in the California carbon allowance futures. So California has a similar emissions trading system. The challenge with investing in carbon via futures or ETFs that invest in futures is figuring out what the carbon price would be because it is very political.

The governments are the ones that set the emission standard. So we don't know if they're going to be even more restrictive or maybe most certainly not less restrictive. And then we don't know what the supply of the emissions allowances will be because that's also set by the government. So it's very much an artificial market. So highly speculative market from that standpoint, but also an incredibly profitable market if you had gone ahead and invested.

in something like KRBN, the Crane Shares Global Carbon ETF, because the futures price of carbon, EUA, went up.

Now, we've looked at five different asset types that we covered two to three years ago. And that's not a very long period of time. And so when we do an episode, we're not definitely covering asset class. We're not forecasting short-term returns. We'll sometimes go through the underlying return drivers to explain what will drive returns going forward. And if we look at the best performance, carbon.

17.3% annualized return, incredibly difficult to forecast and expect a return. This is a speculation because there's disagreement on what the price of carbon should be, and it's an artificial market, highly political. So we can't really come up with an expected return for carbon. The other speculation that we looked at was silver.

Returned negative 5% analyzed since we covered it. But again, now that's a little easier if you really do your homework. You can look at supply and demand. But ultimately, silver hopefully will appreciate over time to be an inflation hedge if you purchase it through an ETF that actually holds the silver bullion. It gets more complicated if you're using futures because of the rollover risk in

in that the spot price has to go above whatever that contract was that you entered into at the time that you, the investor, entered into the contract. And so silver itself is also speculation. There is no cash yield typically with silver. SPACs, special purpose acquisition companies, I just think investors should avoid them due to the conflict of interest with the sponsors and investors.

We have pretty consistent underperformance, an average return of over negative 50% for the SPAC IPOs that went through with an acquisition. So that's not overly attractive to me.

The two asset classes that I feel the best about are convertible bonds and frontier markets. Convertible bonds, as we mentioned, have an expected return over the next decade or so of about 8%. And that's based on this current yield to maturity of 4.3% to 4.8%. And assuming the stock market's positive and the convertible bond ETFs capture half of the stock market's upside, that's an additional 3.7% annualized return for a combined return

8%. That's attractive. Now, there can be volatility there, but right now, the convertible bond indices that the ETFs follow are more diversified, about 40% in technology, but there isn't necessarily one holding dominating like we saw three years ago when Tesla dominated the index. So it's more diversified and an attractive asset class. And then frontier markets, their returns potentially 8% annualized also if...

Earnings come in and valuations stay the same or improve because we're looking at an element of the equity market, the stock market, that has a 4.6% dividend yield. So that's attractive and we'll see how it performs over the next decade. But convertible bonds and frontier markets are the two asset types that we have revisited that I feel most positive about.

SPACs the most negative, and carbon and silver, there are speculations. You enter those at your own risk, not knowing how those will turn out because you don't have the cash flow to feel confident that the return will be positive. That ends our review of five asset classes we've covered over the last three years. Thanks for listening.

Everything I've shared with you in this episode has been for general education. I've not considered your specific risk situation. I've not provided investment advice. This is simply general education on money, investing, and economy. Have a great week.