What Are IPO ETFs and How Do They Work?

Reddit Inc.’s IPO is attracting the attention of market observers as the first major initial public offering of 2024 and will provide a gauge for investor sentiment and appetite for new listings to come this year. 

Meanwhile, investors may want a closer look at IPO ETFs to learn how they work and if they can be a smart way to gain exposure to this market.  

What Is an IPO ETF?

An IPO ETF is a type of exchange-traded fund that invests primarily in stocks of companies that have recently gone public through an initial public offering (IPO). These ETFs provide investors with exposure to a diversified portfolio of newly public companies without having to select individual stocks. 

Here's how IPO ETFs work: 

• Selection process: IPO ETFs typically follow a specific index or strategy to select and invest in newly public companies. This selection process may vary depending on the ETF provider but generally involves including companies that have recently gone public within a certain timeframe, such as the past six months or year. 
• Diversification: IPO ETFs aim to provide investors with diversified exposure to a broad range of newly public companies across various sectors and industries. By holding a basket of IPO stocks typically not found in broad market indexes, these funds help spread risk and mitigate the impact of any individual company's performance on the overall portfolio. 
• Active management or passive tracking: Some IPO ETFs are actively managed, meaning that a portfolio manager actively selects and manages the holdings based on their assessment of the companies' prospects. Others may passively track an index that follows a predefined methodology for selecting IPO stocks. 
• Performance: The performance of an IPO ETF depends on the performance of the underlying IPO stocks it holds, as well as prevailing market conditions and investor sentiment. Thus, performance for these funds tends to vary from year to year and may not move closely to a broader market index, such as the S&P 500. 
• Risks: Investing in IPO ETFs carries certain risks, including the inherent volatility associated with newly public companies. IPOs can be more volatile than established stocks due to factors such as limited trading history, uncertainty about future prospects, and potential hype or speculation surrounding the IPO. Additionally, IPO ETFs may have higher expense ratios compared to more traditional index ETFs. 

The 3 Top IPO ETFs by AUM

Data as of March 20, 2024. 

First Trust U.S. Equity Opportunities ETF

The First Trust U.S. Equity Opportunities ETF (FPX) tracks the IPOX 100 U.S. Index, which is a market-cap-weighted index of the 100 largest U.S. companies with recent IPOs over the first 1,000 trading days for each stock. Stocks are eligible for purchase after the 6th trading day's close and sold on the 1,000th, which is a holding period of about four years. 

FTX’s AUM is $777.8 million, and its expense ratio is 0.61%. 

Renaissance IPO ETF

The Renaissance IPO ETF (IPO) tracks the Rennaissance IPO Index, which is a market cap-weighted index of the largest and most liquid recently listed U.S. initial public offerings. The fund acquires issues within the last three years of an IPO and removes holdings after three years of public trading. 

IPO’s AUM is $188.3 million, and its expense ratio is 0.60%. 

First Trust International Equity Opportunities ETF

The First Trust International Equity Opportunities ETF (FPXI) seeks to track the IPOX International Index, which is a rules-based market-cap weighted index that measures the performance of the 50 largest international firms with recent IPOs. Like its U.S. IPO counterpart, eligible stocks are purchased after the close on the 6th trading day and sold on the 1,000th, for a holding period of roughly 4 years 

FPXI’s AUM is $168.3 million, and its expense ratio is 0.70%. 

Reddit IPO: RDDT Soared 48% on Public Debut

The Reddit IPO was March 21, 2024, enabling investors to buy shares of Reddit, Inc., the San Francisco, CA-based social news aggregator and discussion website, under the ticker symbol, RDDT. According to Reddit’s S-1 filing with the SEC, the company was scheduled to list 22 million shares at a price between $31 and $34. In their public debut, RDDT shares soared 48% following strong interest in the social media platform and online community.

Prior to public trading, Reddit’s IPO was reportedly up to 5 times oversubscribed, which occurs when the demand for shares offered in an initial public offering exceeds the number of shares available. Generally, an oversubscribed IPO is considered a positive sign for the company. It indicates strong investor confidence and can boost the company's reputation and stock price after it starts trading publicly. 

Investors should note that oversubscription doesn't guarantee long-term success. The company's performance after going public will still depend on its fundamentals and execution. 

Bottom Line on Investing in IPO ETFs

The IPO market experiences fluctuations from year to year. For example, in a strong stock market with rising stock prices, companies can capitalize on investor enthusiasm and potentially raise more capital through an IPO. Conversely, bear markets with declining stock prices can discourage companies from IPOs due to lower valuations and investor reluctance. 

In addition to prevailing economic and market conditions, investors interested in IPO ETFs should carefully consider their investment objectives, risk tolerance and investment time horizon before investing. Additionally, it's essential to conduct thorough research on the specific IPO ETF, including its investment strategy, holdings, fees and historical performance.