So you salivate at initial public offerings, do you? You yearn to be able to jump into companies that weren't available as public stocks until recently? If so, you're not alone.
IPOs have a special place in the psyches of many investors, because of the drama that often surrounds them. As my colleague Shruti Basavaraj noted recently, "Some of the biggest standouts in IPO history have been Akamai Technologies (NASDAQ:AKAM), Sycamore Networks (NASDAQ:SCMR), Priceline.com (NASDAQ:PCLN), and Baidu.com (NASDAQ:BIDU) -- each of which popped more than 300% on the first day." Heck, just think of the excitement surrounding Google's (NASDAQ:GOOG) IPO. The stock gained about 25% in its first week.
It's usually been hard for small investors to get in on IPOs early. Their funds are limited, and there are so many IPOs in which to invest. So perhaps small investors will now be cheering -- because First Trust Portfolios LP has just launched its IPOX-100 Index Fund (AMEX:FPX), an exchange-traded fund that will track an index of the top 100 recent IPOs. That's right -- by buying shares of this ETF, which features a reasonable 0.6% expense ratio, you'll instantly be invested in 100 recent IPOs.
Is there anything wrong with this scenario? Well, yeah -- a few things. For starters, IPOs, in general, are not the best investments out there:
- While they often pop strongly on their first day, a year or so out, they've not done so well in a lot of cases. University of Florida Professor Jay Ritter studied 6,000 IPOs that made their debut between 1980 and 2002 and found that, on average, they all underperformed the overall market in their first three years.
- They can be volatile and risky. They're often tied to young companies without long histories of consistent growth and fiscal health. (Of course, this isn't always the case -- some IPOs are for old, established giants, such as Goldman Sachs and UPS (NYSE:UPS), which both made their IPO in 1999.)
- The IPO market goes through cycles of being hot and not. (It seems to be heating up in recent years.) If you buy into this ETF and hang on for a long time, you may end up sitting through some protracted slumps. A recent Dow Jones article noted, "[B]ack-tested data shows the IPOX-100 index gaining 58% in 1999 at the height of the bull market but losing more than 20% in each of the three following years."
Here's my bottom line: If you really want exposure to IPOs, this new option is worth considering. It excludes companies with market caps of less than $50 million and those whose IPO shares pop by 50% or more at their debut -- these tend to do less well in the following months and years. Firms are added to the index in their second public week (which means you'd miss out on any first-day pops) and are held for about four years. Turnover is about 55% per year.
Before you jumpin, take some time to learn more about whether ETFs are really right for you. Our ETF Center will teach you a lot. It features info on how ETFs stack up against mutual funds, how to develop an investment strategy with ETFs, how to avoid pitfalls, and how to steer clear of ETF imposters. There are plenty of ETFs that can give you instant exposure to many emerging-market nooks and crannies.
These articles may also be of interest:
- The ABCs of IPOs
- Mutual Funds vs. ETFs
- Three Things to Know About Your ETF
- Buy the Whole Mall
- The Age of the Exchange-Traded Fund
- ETFs and Falling Fund Fees
Akamai is a Motley Fool Rule Breakers pick, and Priceline is a Motley Fool Stock Advisor recommendation.
Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article.
