2 ETFs Riding Record Year For IPOs

April 22, 2019

The late 1990s were known for their excesses. Stock prices traded at frothy levels that didn’t reflect reality, as investors tossed billions of dollars at anything with “dot-com” in its name.

The threshold for initial public offerings (IPOs)—shares issued into the public market for the first time—was ridiculously low, and countless companies took advantage, raising huge sums of money for questionable business models. Remember Pets.com?

The high-water mark for IPOs was set in 2000, when companies raised $97 billion, according to Renaissance Capital. No year since has come even close to matching 2000 for IPOs (2014 was the closest, at $85 billion), until now.

Renaissance says the deluge of big-name IPOs in 2019 could lead to the best year ever for IPOs. The firm sees the potential for more than 220 IPOs that could raise more than $100 billion. UBS adds that the total market capitalization of these companies could exceed $600 billion.

The ride-hailing company Lyft IPO’d late last month at a $24 billion valuation, putting $2.2 billion in its coffers. Its main rival, Uber, is hoping to raise $10 billion at a $100 billion valuation when it IPO’s next month in what could be one of the 10 largest IPOs ever.

That could be just the start. Slack, Palantir, Airbnb and a host of other tech “unicorns”—private companies with valuations of more than $1 billion—could also start trading publicly this year.

First-Day Pop, Longer-Term Drop

For investors, getting allocated shares to a hot IPO could result in a windfall. It’s not unusual to see double-digit percentage gains from where an IPO prices to where it begins trading on the secondary market. Shares of PagerDuty surged more than 59% in their debut last week, and even Lyft, which stumbled in the days following its IPO, jumped 8.7% on its first trading day.

According to data from UBS and University of Florida professor Jay Ritter, since 1980, the average first-day gain for IPOs has been 18%. That’s nothing to sneeze at—most investors would take a one-day 18% gain without a second thought.

Unfortunately, most investors are unable to get allocated shares in an IPO before it hits the public markets. Those shares predominantly go to investment banks and their top institutional clients.

Instead, investors interested in an IPO will usually have to go to the secondary market to purchase shares of a new stock, after the first-day spike has already taken place.

Buying IPOs this way leads to much less impressive returns. According to the UBS/Jay Ritter data, five-year returns for IPOs purchased on the secondary market were negative in 60% of cases. Though on the positive side, a small handful of stocks had phenomenal returns of hundreds or even thousands of percent.

Those big winners are why the average five-year return for IPOs is 11%, though that is still 2% below the return of the benchmarks.

IPO ETFs Outpacing Market

The data seems to suggest that blindly buying all IPOs on their first day of trading isn’t a long-term winning strategy. Still, the chance to invest in the next big growth stock like Google or Apple is a seductive thing, so investors will almost certainly stay interested in IPOs.

(Use our stock finder tool to find an ETF’s allocation to a certain stock.)

The IPO strategy has even found itself a fan base among ETF investors. There’s a handful of ETFs out there that hold shares of newly minted IPOs, including the First Trust U.S. Equity Opportunities ETF (FPX), with $1.1 billion in assets under management (AUM), and the Renaissance IPO ETF (IPO), with $37 million in AUM.

The smaller IPO ETF has done well this year, gaining 30.5%, just short of double the S&P 500’s 16.4% gain in the same period. The competing FPX hasn’t done as well this year, but its 20.2% gain still outpaces the S&P 500.

 

YTD Returns For FPX, IPO, S&P 500

Note: Data measures total returns for the year-to-date period through April 17

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