Everyone wants to get a head start on buying into tomorrow's hottest stocks. But before you assume that you're really going to get the inside track on a hot IPO, you need to check the details. You might be disappointed to discover that you don't get any better treatment than anyone else who bought shares on the open market.
Within the universe of exchange-traded funds, one ETF seems to hold the key to the IPO market. Look at the holdings of the First Trust US IPO Index ETF
The benefits of IPOs
Initial public offerings get huge amounts of attention, and for a very good reason: They're designed to attract investor interest. Companies put on road shows encouraging financial professionals and potential investors to create a buzz about their IPO shares, in the hopes that demand will provide a burgeoning market in the stock once it trades publicly.
Of course, a successful IPO means different things for different people. For the company going public and the underwriters working on the IPO, making sure the new stock has enough buyers at an acceptable price is crucial. But for investors who are fortunate enough to be able to buy shares directly from the company, success is often measured by how big a pop the shares have once they start trading on the secondary market.
Two examples show how this tug-of-war typically plays out. For SodaStream International
In contrast, General Motors
Bowing out entirely
As you can see, first-day IPO trading can be a crapshoot. But as it turns out, the First Trust ETF neither gets inside access to IPO shares nor tries to grab shares in the chaos of the first few trading days. Instead, the index it tracks waits until the end of the sixth trading day before adding a new company. In other words, the ETF doesn't have any advantage over what you could do yourself.
Nevertheless, the fund offers an interesting mix of huge successes and big failures. For instance, Molycorp
On the other side of the coin, Smart Technologies
A good fund?
On the whole, the First Trust ETF has put up good performance lately, with average gains of 37% annually in the past two years. Longer term, though, the fund's performance has been a lot less impressive. Those gains fall to just 1.4% per year since early 2007 -- enough to outperform the S&P 500, but certainly not jaw-droppingly impressive.
Given that the ETF is market-cap weighted, its big positions overwhelm some smaller picks. GM, for instance, makes up more than 10% of the fund, while Molycorp is less than 1%. Because of that, you may prefer to take your own positions rather than counting on the IPO index to make picks for you.
IPOs are an interesting investment opportunity. But without true inside access, those first-day pops that IPOs are famous for are just as likely to hurt you as help you.
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