IPOs aren’t just sexy, they’re big bucks and they’re really heating up.
According to Nasdaq, the number of IPOs in 2013 has already surpassed the total from 2012. More impressive:Through August of this year, the amount of IPOs generated is the second highest since 2000.
To the chagrin of many investors, however, most ETFs are missing out on the fun.
The governing documents of most indexes dictate a “seasoning” period that bars IPO companies from inclusion. To be fair, the series of failed or glitched IPOs over the past couple years, including Facebook and BATs, highlight the motive behind seasoning rules.
Still, the IPO allure resonates deeply for investors—and understandably so. For example, the one ETF that embraces IPOs instead of shunning them, the First Trust US IPO Index Fund (FPX), is outperforming like crazy .
As an IPO fund, FPX doesn’t have any seasoning rules.
It is, however, bound by a time-lag that has a similar effect. FPX’s portfolio is reconstituted and rebalanced quarterly, so new IPOs might not be included in FPX for as long as three months—not much shorter than some seasoning periods.
There may be a solution coming to market soon: Renaissance Capital plans to launch an IPO-focused ETF based on its own Renaissance IPO Index.
According to the index’s governing documents, new IPOs are promptly added to the index at the end of their first trading day.
Renaissance’s proposed ETF would give investors quick, systematic access to IPOs without the need to carefully analyze each IPO. We don’t yet know which exchange the ETF will be listed on or what its ticker will be. But we do know that it will have the same annual expense ratio as First Trust’s FPX—0.60 percent, or $60 for each $10,000 invested.
IPO funds such as FPX or Renaissance Capital’s proposed ETF don’t have much support in the way of established investment theory. In fact, the entire idea flies in the face of some established theory.
Still, I have a sneaking suspicion that large swaths of investors really don’t have much regard for what economists or financial theorists have to say on the topic.
First Trust’s FPX is currently the only way to directly play the metamorphosis that is the transition of private companies into public companies. However, strategies focusing on accessing private companies are much more plentiful.
It’s true:Investors can use ETFs to invest, indirectly, in private companies. The four ETPs below each take slightly different approaches, but ultimately all invest in publicly traded business development companies which, in turn, invest in private companies.
Going the business development route will cost you, however, as these are some of the most expensive ETPs on the market. The Market Vectors BDC Income ETF (BIZD), for example, has an expense ratio of 7.56 percent—$756 for each $10,000 invested!—giving it the dubious honor of being the most expensive ETP currently on the market.
Investors who prefer to wait for IPOs to go through their seasoning periods before emerging into their ETF portfolio will face various waiting periods—depending on the underlying index and its provider.
The most popular S'P indexes, including the S'P 500, S'P MidCap 400 and the S'P SmallCap 600, have seasoning periods ranging from six to 12 months, depending on judgments by their respective investment committees.
MSCI’s seasoning methodology is similar but slightly less stringent:It requires that “the new issue must have started trading at least three months before the implementation of a Semi-Annual Index Review.”
It’s worth noting, however, that this requirement applies only to small new issues. Large IPOs aren’t subject to the minimum trading requirement.
Ultimately, seasoning periods vary from one index provider to another.
The takeaway here is that investors seeking IPO exposure will need to consider IPO funds like First Trust’s FPX or, when its launches, Renaissance Capital’s ETF.
At the time this article was written, the author held no positions in the securities mentioned. Contact Spencer Bogart at firstname.lastname@example.org or follow him on Twitter @Milton_VonMises.
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