Don’t Chase Alibaba Or Anything With An ETF

September 18, 2014

Why smart investors ignore headlines.

It’s extremely tempting to make every story an ETF story. After all, there are now ETFs that cover virtually every corner of the investing universe. The two-week marketing blitz by Alibaba has made this even more tempting.

Virtually every call I’ve fielded from reporters in the last two weeks has included the question “What does BABA mean for ETFs?”

Look, I get it. It’s the story of the day. And of course, we did the deep, deep dive on exactly where and when BABA will show up in ETF-land. It’s an interesting story, but honestly, it’s deep wonkery.

Yes, it’s curious that BABA won’t even end up in tech funds that rely on the Standard. And because it’s a New York-listed Chinese company, it slips through the cracks in the MSCI methodology and won’t end up anywhere until the rules change.

But let’s be honest, as an investor, these facts should be irrelevant. I have nothing against Alibaba, or initial public offerings. It’s a giant company with a real business, and one assumes that, by going IPO, they’ll be able to raise additional capital to do more awesome things. It’s capitalism at its purest, and I’m all for it.

But I’m not generally a fan of single-stock risk in a portfolio, and I’m really not a fan of IPO risk in a portfolio.

The IPO Problem

A lot of people are going to trade Alibaba tomorrow. A lot. The vast majority of those people will not be investing. They’ll be gambling. The IPO will “price” at something like $68 a share. The question then becomes “So what?”

All the folks getting allocations at that price will have free rein to sell it. So will roughly $8 billion in insider holdings that are not part of the IPO allocation. That’s nearly one-third the value of the shares already being dumped into the market through allocations.

In other words, that’s a lot of sellers. To drum up demand, Alibaba has been on a roadshow, and working the phones. They want a marketplace frothy and full of speculators to at the very least keep the IPO trading around its initial price, or ideally, to run up ridiculously like they did in the late ’90s.

The jockeying to get in is understandable. If anyone has the axe on IPO data, it’s Professor Jay Ritter at the University of Florida. His website has more data on global IPOs than you can find anywhere else. But all you really need to know is that yes, on average, IPOs close on their first day well above their initial prices.

 

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