As IPOs Revive, Should You Be Joining In?
After a few comatose years, the IPO market is roaring back to life.
Initial public offerings started to slow down in 2008, when about 100 companies filed to go public, says Tracey Panek, an editor at Hoover's. Then, the financial crisis hit in earnest -- and sucked all the credit out of the room.
"IPOs dried up," says Frank Fantozzi, CEO of Planned Financial Services. "With the investment banks going into a shell, there was no financing to create the leverage needed. Plus, investors were afraid to invest when they saw their 'safe' investment values cut in half, so there was no market."
Fast forward to today. "Markets have stabilized, and the balance sheets of companies are the strongest in 30 years," says Fantozzi. "Investment banks are looking to make deals."
Simply put, says Panek, "More companies are reassured that they can get the money they need to expand and grow their business by taking their company public on the stock market. It costs at least $50,000 to take a company public, and a company wouldn't want to waste that if there aren't any interested investors."
At Least 300 IPOs in 2011
As the market continues to rise, the size and the excitement of IPOs is once again beginning to intrigue small investors -- and with good reason. "Who wouldn't want to have gotten in on the ground floor of Microsoft (MSFT), Amazon (AMZN), Apple (AAPL), to name a few," points out certified financial planner Michael Kresh.
With 156 active IPOs in the pipeline as of Monday, according to ipoboutique.com, there's plenty of action. And year-to-date through Feb. 16, 24 IPOs have been priced, nearly 85% more than by this time last year, according to Renaissance Capital, a provider of independent IPO research and investment services. That group included Freescale Semiconductor with its $1.15 billion offering.
Panek believes the IPO pipeline is only likely to grow. "It's a safe bet to say at least 300 for all of 2011."
"The sheer number of companies filing IPOs suggests the market is regaining momentum," says Panek. "Also, the diversity of industries -- it's not just tech companies or venture-backed companies that are filing." Among the industries with prospects are real estate, health care, aviation and even oilfield services. Still, it's the rumors about names like Facebook and Groupon that account for the biggest chunk of the uptick in general interest.
How Average Joes Can Invest in IPOs
But what does this mean for the average investor? Access to the "hot names" in the primary market are reserved for investment banks' top clients, says Michael Gault, a senior portfolio strategist at Weiser Capital Management. "And depending on the issue, even the best clients will have a difficult time getting the allocation they desire."
However, there's another way to skin the IPO cat -- the First Trust U.S. IPO Index Fund (FPX). This exchange-traded fund seeks investment results that correspond generally to the price and yield (before the funds fees and expenses) of the IPOX-100 U.S. Index, which is a modified value-weighted price index measuring the performance of the top 100 companies ranked quarterly market capitalization in the IPOX Global Composite Index.
It's a rules-based, value-weighted index measuring the average performance of U.S. IPOs during their first 1,000 trading days. The index is reconstituted and adjusted quarterly. The ETF is promoted as an investment tool for buy-and-hold investors seeking timely and systematic IPO exposure, as well as for active market participants.
But as with any investment, it isn't without risk. The fund's own fact sheets state that its return may not match the return of the IPOX-100 U.S. Index. The fund may not be fully invested at times, it generally won't buy or sell securities in response to market fluctuations and the securities it buys may be issued by companies concentrated in a particular industry.
Also, the fund may invest in small- and mid-cap companies, which may experience greater price volatility than larger, more established companies. And it's classified as "non-diversified" meaning it may invest a larger percentage of assets in the securities of a smaller number of issuers. As a result, the fund may be more susceptible to the risks associated with these particular companies or industries, or to a single economic, political or regulatory occurrence affecting these companies.
Don't Be Fooled By the Name
"FPX is an interesting option. But it's important to note that investors will not participate in any gains in the first week of trading, which is oftentimes where companies see the biggest appreciation," points out Gault. On average, IPOs in the U.S. earned 16% to 18% on the first day of trading, measured by their closing price, according to Lena Booth, a finance professor at Thunderbird School of Global Management.
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Though 100 companies are in the index, more than 37% of the fund's assets are in the top five holdings, and almost half of the fund's assets are in the top 10 holdings.
"This ETF is not allocated shares in the primary market, and it's not participating in the IPO market to the extent that the name leads investors to believe," says Gault. "They need to understand what they are buying."
If an IPO fund could get the IPOs at their offer prices, it would benefit individual investors more, says Booth. However, given the relatively low fees of the FPX fund, "It is a good choice for investors who want to buy newly issued stocks, but want to diversify firm-specific risk by buying a portfolio of them rather than a single one or a few," adds Booth
From Jan. 1 through Feb. 16, the fund was up 5.44%. In the last six months it was up 27.25%. And from a year ago, it was up 28.71%, according to fund research firm Morningstar (MORN).
Play Carefully
IPOs may have a lot of hoopla surrounding them, and in the early going, they can provide impressive gains. However, their longer-term performance -- three years after IPO -- doesn't hold up as often, says Booth. "Research has shown that long-run performance of IPOs trails seasoned companies' stock on a risk-adjusted basis," she adds.
So, if you're going to get into the IPO game, play carefully. "Treat it more like a sector," recommends Fantozzi. "Consider allocating a portion of your portfolio to it for a period of time."
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