If you’ve experimented with IPOs, you’ve probably been burned in the past. And chances are you’ve given up on the endeavor.
And if you’re a fund investor, you most likely don’t have an allocation to an IPO-related fund (mutual fund or ETF). After all, there just aren’t many to choose from.
Plus, if you’re buying broad-based index funds, which more investors are doing nowadays, there are barely any IPO holdings inside.
For example, I used the ETF Research Center’s overlap tool to compare the SPDR S&P 500 ETF (SPY) and the two existing IPO ETFs that concentrate on U.S.-listed IPOs.
SPY has only 14 overlapping constituents — or 3% weighted-overlap with one IPO ETF.
And SPY has just two overlapping constituents — or a rounded 0% weighted-overlap with the second IPO ETF.
Another deterrent is that many investors assume the only way to make outsized gains through IPO investing is reserved for the rich and famous.
That is, they expect that large investment firms divvy up their pre-IPO share allotments to select high-net worth clients. In turn, they also expect these filthy-rich investors will quickly dump their shares when the stock hits the open market.
But, according to research conducted by University of Florida economics professor Jay Ritter, there’s another way to make money off IPOs.
And if you’re a “little guy” looking to get into the big world of IPO investing, this may be the opportunity you’ve been waiting for …
Ritter observed more than three decades of outperformance, from 1980 to 2012, in IPO stocks with the largest revenues before they went public.
In his study, Ritter determined that the strategy of buying big company IPOs at the first closing price — and holding for three years — outperformed the S&P 500 by 2% per year.
And in 2016, we’re seeing evidence of that kind of outperformance. Since the market’s bottom on Feb. 11, take a look …
[FPX is the First Trust US IPO Index Fund and IPO is the Renaissance IPO ETF. More on both these funds in a bit.]
This year, the average IPO is up 32% from its offer price in 2016 (45% ex-biotech). And 81% of deals are trading above issue (95% ex-biotech).
After taking a deeper look, several IPO stocks issued within the last year and a half — with deal sizes of $250 million or more — have seen significant appreciation after their “first-day pop” …
National Storage (NSA) up 55% (offer date 4/22/15)
Black Knight Financial (BKFS) up 48% (offer date 5/9/15)
TransUnion (TRU) up 35% (offer date 6/24/15)
Performance Food Group (PFGC) up 33% (offer date 9/30/15)
GoDaddy (GDDY) up 32% (offer date 3/31/15)
Grupo Supervielle (SUPV) up 21% (offer date 5/18/16)
Red Rock Resorts (RRR) up 21% (offer date 4/26/16)
Remember, the above return totals exclude each stock’s typical first-day price jump.
Now, in all fairness, there’s been a major lull in IPO activity this year. Especially during the first couple months of 2016. However, things have been picking up recently.
|Source: Renaissance Capital|
Since April, the IPO market has averaged 10 deals per month. And a post-Labor Day acceleration might be in order.
As of Sept. 1, 100 companies were publicly on file for U.S. IPOs. These companies are seeking to raise a combined $24 billion. (As opposed to the 59 IPOs that raised $9.8 billion year-to-date.)
That means there could be a lot of new IPOs to choose from.
If there’s an upswing in actual IPO pricings coming our way, investors could see more strong returns ahead.
I spoke to Kathleen Smith, a founder and principal of Renaissance Capital (“The IPO Experts”), the other day. She told me:
“Our studies show the returns on IPOs show outperformance in the months following dry spells. This is because only the strongest, most attractively valued companies are able to tap the IPO market during those times.”
So, what’s the best way to play the IPO market if you’re not part of “the 1%”?
It’s choosing one of the two ETFs I mentioned earlier. Let’s quickly review each one.
The First Trust U.S. IPO Index Fund (FPX) launched over 10 years ago.
It aims to track the IPOX-100 index. This benchmark is a rules-based, value-weighted price index that measures the performance of the largest and most-liquid 100 companies ranked by market capitalization.
The IPOX-100 index computes average performance during its IPOs’ first 1,000 trading days. It also places a 10% cap on all holdings and reconstitutes quarterly.
Some recognizable holdings are: Facebook (FB), Kraft Heinz (KHC), AbbVie (ABBV), PayPal (PYPL), Hewlett-Packard Enterprise (HPE), Zoetis (ZTS), Twitter (TWTR), Palo Alto Networks (PANW), Fiat Chrysler Automobiles (FCAU) and TripAdvisor (TRIP).
This ETF gets a 5-star rating from Morningstar (the top ranking available).
Since FPX’s inception, it has a returned a cumulative 193%. In contrast, the S&P 500 Index returned 110% over the same time.
The Renaissance IPO ETF (IPO) is a newer offering with a more recognizable ticker. This ETF launched almost three years ago.
The IPO ETF seeks to track the Renaissance IPO Index, which was designed by the IPO Intelligence team at Renaissance Capital (doing IPO analysis for institutions for a quarter-century).
By design, this index maintains efficient exposure to a portfolio of U.S.-listed newly public companies ahead of their inclusion in core equity portfolios (major indexes, mostly).
Companies within the index are removed two years — or 500 trading days — after their initial trade date, when they become seasoned equities. (The sweet spot, according to Renaissance Capital, for holding IPOs.)
Some recognizable current holdings are: Alibaba (BABA), Citizens Financial Group (CFG), Mobileye (MBLY), TransUnion (TRU), Fitbit (FIT), Shopify (SHOP), Blue Buffalo Pet Products (BUFF), GoDaddy (GDDY), Virgin America (VA) and Square (SQ).
The IPO ETF, since its inception, has underperformed FPX by a wide margin. But this ETF has rebounded very nicely — and outperformed both FPX and the S&P 500 — after this year’s January-February sell-off.
In the end, either ETF is an easy way to get exposure to the IPO market. And both strategies have their advantages.
With FPX, you get a reputable issuer …
A larger-cap portfolio …
A longer history of market-beating performance, and …
A more liquid vehicle.
And with the IPO ETF, you get an ETF/index that’s designed by an IPO specialist (Renaissance Capital’s IPO Intelligence team has been advising institutions on IPOs for 25 years) …
More of an all-cap approach, and …
While lesser known, might actually be the better choice if the IPO market continues to heats up. (It’s substantially outperformed since this year’s market bottom).
By the way, if you’re interested in international IPOs, both shops have those products, too. First Trust has FPXI. And Renaissance Capital has IPOS. You can easily find more information on these ETFs through the website links above.
This article originally appeared on Uncommon Wisdom Daily.
About the Author: Grant Wasylik
Grant Wasylik is an analyst and editor for Uncommon Wisdom Daily — a division of Weiss Research.
Before joining the investment newsletter business, Grant worked as a portfolio manager, lead research analyst and head trader for a billion-dollar wealth management firm for 10 years. He also spent a few years working in a specialized risk-trading department at Charles Schwab — where he was the first-ever, external hire into this elite department. In his first stint in the securities business (after passing Series 7, 64 and 24 exams), Grant ran a margin department and supervised a trade desk for a discount brokerage firm.
Prior to coming to Uncommon Wisdom Daily, Grant was co-editor and chief analyst of The Palm Beach Letter for two years. This monthly publication — with over 70,000 subscribers — focused on safe, income-oriented investments.
Due to his vast investment experience, Grant has a deep contact list comprised of 400-plus mutual fund, ETF, index, hedge fund and other top-notch financial professionals. In addition, he receives special invitations to — and attends — several of the world’s top investment conferences each year.