Are SPACs a good investment?They're red-hot—but they've been a lousy deal for investors

This article is part of Fortune‘s quarterly investment guide for Q1 2021.

It’s a clever way to take a company public: Instead of dealing with the rigmarole of a traditional IPO process, more firms are turning to a “blank check” model. That model involves raising money for a shell company and then using that shell to buy an existing enterprise—a backdoor way to turn a private company public overnight.

Blank check ventures, also known as SPACs (for special purpose acquisition companies), sound like a gimmick, but some firms have used them to go public with great success. These include sports-betting firm DraftKings, whose stock first listed at $19 last April but has since risen more than 150%.

In 2020, SPACs became one of the hottest assets on Wall Street. According to research firm SPACInsider, 248 SPACs raised a total of over $83 billion—a nearly fivefold increase from 2019 when 59 SPACs raised $13 billion.

For the dealmakers who put SPACs together, the upsides are obvious. They can skip the headache of a road show—in which a company’s top executives make the same pre-IPO presentation over and over to would-be investors—as well as avoid the customary 7% fee normally paid to underwriters. Meanwhile, the organizers typically pocket 20% of the SPACs, a reward known as the “sponsor promote” for their trouble. In other words, the SPAC has plenty of upside and almost no downside.

Well, no downside for the SPAC organizers that is. For ordinary investors, though, SPACs have often proved to be a rotten deal. For 107 SPACs that have purchased companies since 2015, the average return on common stock has been a putrid negative 1.4%. That compares with a 49% return for companies that went public via the traditional IPO route during the same period, according to data cited by the Wall Street Journal.

There are various explanations for the lousy returns. These include the fact that SPACs have historically targeted sectors, such as gambling or cannabis, exposed to controversy or regulatory scrutiny. Meanwhile, SPAC operators also benefit from a legal loophole that permits them to promise lavish returns. This means they can hype their stock without facing legal exposure of the sort that would attach to other pre-IPO companies that make unrealistic promises about their performance.

But the biggest reason SPACs have often been a bum deal for investors likely lies with a perverse incentive structure. Namely, those who package the SPAC typically get to off-load their shares as soon as the SPAC acquires a target. This means the SPAC backers are motivated to find a deal—any deal—that will let them cash out, rather than finding the best long-term investment.

“I don’t want to be negative as a whole, but anyone who buys into a SPAC should dig into the underlying company it acquires. You have to make sure there’s underlying quality,” says Gabriel Grego, the CEO of investment firm Quintessential Capital Management.

Grego knows this firsthand. His firm makes a business of selling short the shares of companies it believes are overvalued, and SPACs have been a juicy target for his strategy. In 2019, Quintessential Capital made a winning bet shorting the sales of a SPAC that purchased a streaming service that billed itself as the “Spotify of emerging markets”—but turned out to have very little in the way of customers.

In the past year, a new generation of SPAC entrepreneurs have tried to dispel the sector’s dodgy reputation. These include legendary investor Bill Ackman, whose new SPAC raised a record $4 billion, giving rise to rumors it might purchase Airbnb (which has since gone public the traditional way).

Another prominent figure who wants to give new respectability to SPACs is Paul Ryan, the former Speaker of the House. Ryan is now chairman of Executive Network Partnering Corp., a SPAC born last summer that only granted a 5% sponsor promote to its executives, while offering them rewards if the company performs well in the long term. At a recent Fortune event, Ryan claimed this eliminates the perverse incentive problem that has dogged other SPACs.

But even if the likes of Ackman and Ryan can make the SPAC sector less dodgy, would-be investors should be wary of another risk: a glut of blank check companies looking for targets. As hundreds of new SPAC operations circle for acquisition opportunities, it’s improbable all or even most of them will find a worthy target. After all, stellar startups with the prospect of future profits are not a dime a dozen—and many of those that meet those criteria will look to find their own path to the public market rather than hooking up with a SPAC.

Purchasers of SPAC stock do have one key protection, though. They have the right to make the SPAC pay them back for the stocks they bought with interest if the company does not make an acquisition within two years, or anytime before then. But while this does provide investors an escape hatch, many may not exercise it and will end up stuck holding shares of a SPAC that rushes into an ill-advised acquisition.

As for Grego of Quintessential, he is not down on the SPAC sector as a whole, saying those who do their research can find sound individual investments. But he is skeptical that changes to the sponsor promote structure, like the one deployed by Ryan’s firm, will be enough to eliminate the risks.

“You still have perverse incentives because the downside is zero and the asset is large. [Changes to the sponsor promote] mitigate the problem but don’t eliminate it,” says Grego.

In the longer term, Grego predicts that the appetite for SPACs will wane once the broader bull run in the stock market cools off. In the meantime, he says, his company has started a fresh research project looking for SPACs to short.