Last week, exchange-traded funds entered yet another realm of investing with the launch of the IPOX-100 Index Fund (AMEX:FPX). This one lets you invest in IPOs -- specifically, the 100 largest IPOs in terms of market cap, from the seventh day after the IPO until the new stock's 1,000th day of trading. Thus, you'll see stocks such as Google (NASDAQ:GOOG) in the index.
Think of an ETF as a mutual fund that trades on a stock exchange. It typically has very low fees and is based on a particular index. Since an ETF trades like a stock, you can buy or sell it at any time during the trading day. You can even short an ETF. In a nutshell, it's a versatile investment vehicle that lets people put their money in a myriad of areas all at once, from commodities to sector-specific funds.
But aren't IPOs high-risk? Well, they can be. For example, an obscure small-cap company may not last long. Or a newfangled biotech company may not get approval from the Food and Drug Administration.
Being based on the largest IPOs tends to reduce the ETF's riskiness. The fund's average market cap is about $4 billion. But on the other hand, the IPO market does have a history of extreme volatility. From 1995 to 2000, Internet startups dominated the IPO market, and companies routinely soared. Then, in the post-crash years between 2001 and 2003, only a handful of companies launched IPOs, so it was almost impossible to have 100 firms for an IPO index. So if you are thinking about investing in an IPO fund, it's not a good idea to allocate too much money to it. This is risk capital, and it probably should make up no more than 10% of your portfolio.
In a way, the IPOX-100 Index Fund kind of misleading. IPOs are a lucrative game primarily when you get shares at the offering price -- not after they hit the market. After all, it's not uncommon for investment banks to underprice new issues relative to fundamentals, to attract sufficient demand. In the IPOX-100 Index Fund, you do not necessarily get this inside track.
Instead, this is essentially a mid-cap index -- with a nice marketing angle.
Fool contributor Tom Taulli does not own shares mentioned in this article.
