IPO Follies: Mistakes ‘R’ Us In New ETF

October 24, 2013

The new initial public offering ETF 'IPO' is less than meets the untrained eye.

The recent launch of the Renaissance IPO ETF (IPO) on Oct. 16 generated an enormous amount of interest, gathering $31 million in the first few days of its life.

It’s easy to understand the enthusiasm—investors remember the performance of stocks during the Internet boom, and there’s something very, well, American, about getting in on the ground floor of some scrappy upstart company and riding it to the moon.

The new ETF tracks a reasonably well constructed index that includes an initial public offering after it’s been trading for five days, then holds it for two years.

That’s the first big mistake I’m seeing in the traffic around the fund “IPO.”

That “fast entry” on the fifth day of trading mechanically guarantees that ETF will buy after the initial “pop” in a hot IPO.

Consider the most recent IPO on the street, Voxeljet (VJET). VJET priced at $13 on Oct. 17. Today is the fifth day of trading, so the issue should become one of IPO’s holdings tomorrow. VJET is currently trading at $30. That more-than-double pop is the magic of IPOs that many investors are hoping to capture. But holders of IPO will be buying at $30. That’s not so great.

Because of this “buying-after-the-pop” issue, the actual strategy IPO is following really just isn’t that exciting in the rearview mirror.

Since the 2009 inception of the index IPO tracks—the Renaissance IPO Index—it’s returned an average annual return of 19.09 percent, just a touch over the Russell 3000’s return of 18.97 percent. Add in the effect of a 60 basis point management fee and it’s easy to be skeptical about whether the long-term returns will really play out for investors.

But that cautionary note seemed to be lost on the markets when IPO launched. In the first day of trading, IPO traded more than 800,000 shares. That’s a big day for a new niche ETF. Unfortunately, the folks who were trading during that initial feeding frenzy caused an irrational “IPO pop” of their own.

 

1 - IPO IPO

 

The blue line is the traded price of IPO. The green line is the fair value of IPO as measured by the broadcast intraday net asset value (iNAV).

In this case, all of the holdings of IPO are reasonably liquid and trade on U.S. markets, so that the iNAV line is pretty accurate. And it’s not the case that that pop in traded price represented some kind of market breakdown. Trading in IPO remained orderly and relatively efficient all the way up, and all the way down in that first crazy day.

 

 

 

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