FPX buys IPOs and spinoffs on the sixth day of trading and holds them for 1,000 days thereafter. The spinoff addition provides an added benefit, but the most beneficial feature is the longer holding period. The fund also excludes companies that experience higher-than-average underpricing, essentially the largest first-day performers.
Renaissance IPO buys only IPOs on the sixth day of trading and holds them for just 500 days, and includes liquidity screens, but has no measurements for mispricing. The fund has also struggled to provide beneficial exposure since inception.
For investors attracted to IPO investing, these are great vehicles. For indifferent investors, such as we at CLS, they’re not favorites, at least not now.
These funds hold securities that are, on average, much more expensive than the overall market. Also, the underlying companies tend to be lower quality (i.e., less profitability, higher debt levels) than the typical stock.
Given our preference for higher-quality companies, particularly in this market environment, IPO investing is less attractive.
An Alternative To IPOs
One ETF we find attractive in the current environment invests in funds that are similar to IPOs but not quite the same: closed-end funds (CEFs). It is the PowerShares Closed End Fund Income Composite Portfolio (PCEF).
Like IPOs, CEFs are generally introduced with great fanfare, supported by strong sales and publicity efforts. Because of this attention, both stocks typically have strong price runs to start. IPOs see valuation spikes before faltering, and CEFs see price premiums to their net asset values before faltering. Once the initial promotion wears off, however, many CEFs begin to trade at discounts to net asset values. At this point, CEFs can become attractive.
CEFs might become even more attractive if the discounts get larger, like they are now. Recently, CEFs were trading at their steepest discounts in eight years. Unlike IPOs, which are generally expensive, CEFs are on sale. The fund we like, PCEF, takes advantage of discounts in CEFs.
That’s a story to get behind.
Grant Engelbart also contributed to this article.
At the time of writing, CLS Investments held a position in FPX and PCEF. CLS Investments is an Omaha, Nebraska-based third-party investment manager and ETF strategist. CLS began to emphasize ETFs in individual investor portfolios in 2002, and is now one of the largest active money managers using exchange-traded funds, with more than $2 billion invested. Contact CLS’ Marketing Communications Specialist Sadie Brewer at 402-896-7406 or at [email protected]. Please click here for a complete list of relevant disclosures and definitions.