Initial public offerings – or IPOs – are popular among day traders for their extreme price swings that frequently exceed 100% in a single day.
For example, LinkedIn Corp.’s (LNKD) shares more than doubled during their public trading debut on May 19, 2011. Facebook, Inc.’s (FB) IPO wasn’t so smooth with a series of technical problems cutting an early rally short and sending the stock lower than its opening share price.
In this article, we’ll take a closer look at IPO performance, niche exchange-traded funds that track IPOs, and whether investors should consider them.
How Do IPO’s Perform?
Many initial public offerings see strong price performance on the first day or two, but long-term performance tends to be mixed at best. According to University of Florida’s Jay Ritter, the average first-day return for an IPO between 1980 and 2014 was 17.9%, but the average IPO lags the returns of similar non-IPO stocks by 6.3%. It’s worth noting that large-cap IPOs tend to significantly outperform small-cap IPOs despite their smaller first-day returns.
While simple buy-and-hold strategies may fail over the long term, some investors wait for an initial sell-off before purchasing the stock at a discount. The idea is that many pre-IPO shareholders would be looking to sell stock early on, which could artificially depress the stock price and create an opportunity for long-term investors. Ritter’s research also shows that IPO stocks with the biggest sales revenue tend to outperform the market over the long run.
Investing in IPOs with ETFs
Investors looking for diversified exposure to a wide range of initial public offerings may want to consider exchange-traded funds focused on these opportunities. While these ETFs provide exposure to IPOs, they use different strategies that have a significant impact on their returns. Investors should carefully consider these differences before investing in IPO ETFs to avoid unexpected problems, like missing out on a popular IPO due to a fund’s rules.
Some of the most popular IPO ETFs include:
|(FPX )||First Trust US IPO Index Fund||4.43%||4.34%||26.66%||131.61%||April 12, 2006||0.60%|
|(IPO )||Renaissance IPO ETF||-0.30%||-0.53%||3.76%||N/A||October 16, 2013||0.60%|
|(IPOS )||Renaissance International IPO ETF||-3.76%||-2.44%||N/A||N/A||October 6, 2014||0.80%|
The outperformance of the First Trust US IPO Index Fund (FPX ) relative to the Renaissance ETFs is primarily due to its approach. Rather than selling within the first two years, the ETF holds stocks up to four years after an IPO, which provides exposure to more mature IPO companies. The ETF is also tilted toward mid- and large-cap IPO stocks, which tend to outperform micro- and small-cap IPOs by a wide margin based on Ritter’s research.
Investors can filter through IPO ETFs based on a variety of different criteria – ranging from returns to expense ratios – using the ETF Screener.
The Bottom Line
Initial public offerings have become extremely popular among day traders, but their usefulness for long-term investors is debatable. Researchers have shown that most IPOs tend to underperform the market, but there are some exceptions when it comes to larger IPOs with over $100 million in revenue. IPO ETFs targeting the industry take a variety of approaches to the market that influence their risk and reward profile for investors.
Investors can check out the ETF Launch Center to identify other niche ETFs that may be of interest to those looking to control for risk and alpha.