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.




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.




2 - IPO Premia


The bid/ask spread averaged just 6 cents in the first few days of trading, and at the very peak of the insane premium, the spread widened out to “only” 19 cents. Remember that 6 cents on $20 is about 30 basis points, and in the land of IPOs, that’s pretty reasonable. Obviously, issues like Facebook trade a penny wide all day long, but consider firms like Intrexon (XON), the smallest holding in IPO:


3 - XON Spread


Trading in XON could best be described as “sloppy,” as witnessed by spreads that, while averaging just 20 basis points, can spike as high as a few percent.

The moral of the story here is simple: Beware the hype.

There was no logical reason to pay more than fair value for IPO on launch day.

The reason it traded to a premium, most likely, is that the sole AP for the fund, Knight, was caught off guard. The underlying stocks are plenty liquid, so there’s no reason to think Knight couldn’t make more shares, and obviously, with $31 million now in the fund, Knight indeed made more shares in a hurry. So the premium present in that first day’s trading was entirely irrational, and predictably collapsed.

To anyone who bought at that irrational price, all I can offer is my condolences. And perhaps a reminder that, in the end, fair value always wins.

At the time this article was written, the author held no positions in the securities mentioned. Contact Dave Nadig at [email protected].



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