One firm’s new, long-term approach to SPACs

Chicago-based RiverNorth Capital Management in its offering of multiple fund structures across a variety of niche markets is straddling the mainstream alternative investment divides, just like the city’s famous drawbridges span the Chicago River’s winding path through the Loop.

The firm kicked off its 20th anniversary year with the launch of its first SPAC Arbitrage Fund in January. In a year when SPACs have dominated the headlines, the new fund was no small move. The RiverNorth SPAC Arbitrage Fund too caps off a string of long/short opportunistic fund offerings that are part of a broader fund line-up including open-end funds where brand name alternative credit specialists Oaktree Capital Management and DoubleLine Capital are sub-advisors.

Patrick Galley (provided)

RiverNorth CEO/CIO Patrick Galley is responsible for strategic planning and business development and oversees all portfolio management activities at the $4.4 billion firm. In addition, he serves as the President and Chairman of all RiverNorth proprietary funds.

He took some time recently to speak to Alternatives Watch exclusively about the firm’s history and how the team is approaching the current SPAC craze.

AW: RiverNorth Capital Management just celebrated its 20th anniversary this year, what has changed and what has stayed the same?

Galley: RiverNorth was founded in 2000 as a traditional registered investment advisory firm. In 2004 we changed the focus of the firm and started to opportunistically invest in closed-end funds. As we grew we continued to favor under-followed, specialty asset classes in niche markets where the potential to exploit inefficiencies is the greatest. In addition, on several of our funds we have partnered with exceptional investment managers renowned for their particular expertise. Today, RiverNorth is an institutional investment manager to registered funds, private funds and separately managed accounts.

AW: SPACs have attracted a lot of attention in 2020 and your firm has been active in this space. What makes RiverNorth’s strategy unique?

Galley: RiverNorth’s SPAC strategy is relatively conservative. We typically buy units which consist of common shares and warrants, and then hold both until an acquisition target is announced by the SPAC.  If the common shares then trade above the trust account value we will sell them in the market at some point, but if they don’t then we will redeem the common shares for the value in the trust account. Depending on how both the common shares and warrants are trading, we will often hold on to the warrants until after an acquisition has closed.

AW: How has the SPAC market overall changed and why did RiverNorth start to focus on this structure?

Galley: Historically SPACs have been considered something of a last resort for companies looking to go public or in need of funding. Over the past several years there have been many highly respected institutions that have sponsored SPACs and very good companies that have gone pubic via SPAC, which has changed the perception of them.  Now SPACs are really considered a legitimate alternative to a traditional IPO. RiverNorth started to focus on SPACs because the downside mitigation along with the upside optionality of the SPAC structure was a good fit for many of our strategies that typically held some amount of cash in the portfolio.  In other words, we felt the risk of holding a SPAC portfolio was similar to holding cash, but the return potential was higher.

AW: What do you look for in terms of warrant coverage in SPACs?

Galley: Typical warrant coverage recently has been 1/2 or 1/3 of a warrant per unit.  The warrant coverage is dependent on the likelihood of a management team closing an acquisition that is favorably viewed by the market – the higher the likelihood of a good acquisition, the lower the warrant coverage needs to be.  We look at the background and experience of each SPAC management team and based on that determine what we believe an appropriate warrant coverage should be.  If the warrant coverage is lower than we think it should be we will likely choose not to invest.  Alternatively, if the warrant coverage is higher than we would expect, we may overweight the SPAC in our strategies.

AW: Do you believe SPACs have become a more important, long-term part of investor portfolios?

Galley: SPACs have been in the news a lot over the past year, but it is still a relatively niche market.  While we have seen new investors enter the space, it is not clear how many are treating SPACs as long-term portfolio holdings vs buying into a currently hot market.

AW: RiverNorth also is very active in closed-end funds and BDCs. How do those offerings fit into the firm’s overall offering?

Galley: RiverNorth is one of the largest institutional investors in closed-end funds. Our opportunistic investment strategies are structured in a way to increase closed-end fund exposure as discounts widen and decrease closed-end fund exposure when discounts narrow. 

We offer open-end and private funds that invest in closed-end funds and BDCs. Additionally, we are the investment adviser to several closed-end funds that have underlying allocations to a wide array of closed-end funds.   

AW: What big issues and trends are you looking for in Q42020? 2021?

Galley: For closed-end funds, we believe there could be significant tax loss selling in Q4. Adding in continued economic uncertainty we believe the potential exists for excellent closed-end fund trading opportunities.

Looking forward, low interest rates/borrowing costs combined with dividend hikes may be the catalyst for significant discount narrowing, especially as tax loss selling pressure eases in the new calendar year. Credit performance across top-tier BDCs managed by, in our view, high-quality sponsors and conservative underwriters have overall remained strong, which we believe will continue. However, we anticipate that lower-tier issuers will continue to struggle with additional portfolio write-downs and an increase in defaults and losses. This has been the trend for several years, and in our opinion will likely be further pronounced in the current environment for managers which have not underwritten prudently.

We believe, recent activity in SPACs has legitimized the structure as a viable and efficient path for companies to go public, especially in pandemic/post-pandemic environment. Record issuance also creates a meaningful amount of supply, which in turn creates trading opportunities around potential supply/demand imbalances. Viewed from an investor’s perspective, we believe that the structure continues to offer attractive optionality with relatively little downside (e.g. trust value) and potential for significant upside via the warrants.

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