IPO ETFs (FPX, IPO): A Better Way To Ride The Bull

by on November 13, 2013 | ETFs Mentioned:

The bull market rages on as optimism levels remain elevated thanks to the latest upbeat GDP and employment reports coupled with supportive monetary policy on both sides of the Atlantic Ocean; the Fed’s decision to start tapering remains on hold, while overseas the European Central Bank cut its benchmark rate to a record low of 0.25%. Amid the euphoria, the IPO market has been getting more and more attention as investors look to this lucrative asset class for unparalleled opportunities to buy into the next hot growth stock [see Which ETFs Will Own Twitter (TWTR)].

Thanks to the proliferation of ETFs, investors of all sizes can now more easily than ever access the IPO market through a single ticker; industry veteran and newcomer, the First Trust IPOX-100 Index Fund(FPX, C+) and  the Renaissance IPO ETF (IPO), respectively, allow for easy, cheap, broad-based exposure to this lucrative asset class.

FPX and IPO both look to provide exposure to the domestic market for initial public offerings by tracking benchmarks that capture the universe of newly listed companies. More importantly, these funds warrant a closer look from momentum chasers and long-term investors alike as the IPO market offers a compelling case for those looking to favorably position themselves during bull markets. Though the risks of investing in IPOs are substantial, the exchange-traded fund approach certainly dulls the volatility associated with this asset class and makes it far more accessible for investors of all styles and sizes [see The Complete History Of The S&P 500 Index].

IPO ETFs: Diversified Exposure in a Lucrative Asset Class

Newly listed public companies may be attractive to ETF investors for two simple reasons; first and foremost, IPOs have a tendency to generate stellar returns on their first day of trading alone and investors naturally want an opportunity to buy into a stock that may one day turn out to be the next Apple (AAPL) or Google (GOOG). Second, historical data reveals that IPOs as a whole have delivered impressive returns since the stock market bottom in March of 2009 following the financial meltdown; as such, investors may want to take a closer look and consider the IPO market as an asset class, rather than a stock-by-stock picking challenge.

Consider the monthly performance comparison below between the First Trust IPOX-100 Index Fund (FPX, C+), the SPDR S&P 500 ETF (SPY, A), and the iShares Russell 2000 ETF (IWM, A-) since the inception of the FPX in mid-2006; please note that this examples excludes the recently launched Renaissance IPO ETF to better illustrate the performance of IPOs as an asset class over the span of the current bull market:

The example above illustrates how IPOs as an asset class have outperformed broad-based equity benchmarks, both large- as well as small-caps, since the stock market bottomed out in 2009. There are numerous reasons behind this outperformance, but perhaps the simplest one to take away is that IPOs may be a great way to “leverage” the euphoria that permeates Wall Street during bull markets as investors flock to hot growth stocks with bright prospects [see also A Brief History of ETF Bubbles].

According to Renaissance’s IPO Center, year-to-date there have been 195 new company listings, marking a nice jump from last year’s figure of 128. What’s even more exciting are the performance figures in this corner of the market; the FTSE Renaissance US IPO Index has delivered a gain of 47% year-to-date (as of 11/7) compared to the S&P 500′s return of 22%. Digging deeper, it becomes apparent that the returns vary quite drastically from company to company. While it may be true that the average “first day pop” for IPOs this year has been 17%, picking underperformers like Prosena or Cyan, which are down 71% and 64%, respectively YTD, can set you back significantly. That’s where IPO ETFs come in, as these instruments undeniably make it easier and safer to dip your toes in the lucrative market for newly listed companies.

The Bottom Line

Investing in newly listed companies is very compelling but requires a ton of research and the inherent risks may be too much for certain types of investors. The broad-based approach offered by IPO ETFs deserves a closer look from anyone trying to gain exposure to this lucrative asset class but who wishes to avoid some of the nuances and risks associated with investing in individual newly listed companies.

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