January 30, 2006

First Trust Advisors files for an ETF on the IPOX-100 ETF; also, IPOX partners with S&P to launch European indexes.

Want access to the most innovative companies in America?  First Trust Advisors hopes so.

The growing provider of exchange-traded funds (ETFs) filed papers with the Securities and Exchange Commission (SEC) for the right to launch a new ETF based on the IPOX Schuster IPOX-100 Index, which tracks the "aftermarket" performance of the top initial public offerings (IPOs) in the U.S. stock market.  The IPOX IPO indexes were created by IPOX-Schuster, and are calculated and maintained by Standard and Poors's "Custom Indices" unit.

The IPOX-100 is a sub-index of the broader IPOX Composite, which includes all U.S. IPOs.  The Composite incorporates companies on the seventh trading day after they go public, and holds them through their 1,000th trading day - about four years.  The IPOX-100 selects the 100 largest and best performing IPOs. The 100 rebalances on a quarterly basis, to make the index more manageable from a trading perspective.  Currently, the largest holding is Google.  The index also includes spin-offs, which help make it more stable, as they tend to be established, profitable companies. 

"IPOs are interesting from a number of perspectives," said Josef Schuster, founder and CEO of IPOX-Schuster, the creator of the index.  "Academically, there's a lot of evidence to suggest that IPOs trade differently and are really a separate asset class from other companies.  Also, because the index is constantly updated, it provides exposure to the growth and innovative aspects of the economy (if you believe IPO and spin-off activity is a good proxy for that innovation). It's a good way to get access to equity capital markets activity."

The index has certainly performed well of late, posting three-year annual returns of 27 percent, more than doubling the 12 percent return of the S&P 500 - a fact that Schuster attributes to Sarbanes-Oxley, which has encouraged companies to come public at a more mature stage of development.  But even looking back further, the index has done well: It has outperformed the S&P over the past ten years, delivering 10.21 percent returns against 7.3 percent for the S&P 500. That outperformance is all the more impressive because the index has a decided growth tilt, while value has outperformed growth in years past.  The index also tilts towards small cap companies, however, which may have helped it outperform.

Schuster believes that the IPOX-100 is more attractive than the broader Composite, as "only a few IPOs perform well, while many fall off a cliff."  By selecting the largest and best performing IPOs, the index avoids these failed companies.  

It will be interesting to see what kind of reception the IPO receives. A unit investment trust (UIT) offered by Van Kampen Investments already exists that tracks the IPOX-30 Index, and currently has approximately $65 million in assets.  But the ETF could attract a much larger market, as the UIT comes with onerous expense loads. (No word yet on the expense ratio for the ETF, but it's sure to be lower than the UIT, which charges a 5 percent load.)

An actively-managed IPO mutual fund from Renaissance Capital has been on the market since 2001, but boasts just $19 million in assets.  That fund, however, specifically targets the unloved, under-researched IPOs that the IPOX-100 shuns - perhaps not as popular a category as a fund that focuses on hot firms like Google. (That said, the IPOX Index actually avoids the "hottest" IPOs, by refusing to including any stock that pops more than 50 percent on its first day of trading; Schuster says that including these companies would create a major performance drag, around 2 percent per year since 1989.)

A lot will depend on how IPOX does in educating the public, as even Schuster admits the market isn't clamoring for access to IPOs as an asset class ... at least not yet.

"We didn't create the IPOX indexes because we feel there is a market demand," said Schuster.  "It's just the opposite - it comes from a lot of academic work we have done on the U.S. and European IPO market. The IPO market has interesting empirical dynamics, in terms of correlation and returns.

"We're very happy with the ETF filing, and we look forward to having First Trust as a partner.  This can really bring a benefit to investors who are looking to buy into IPOs, but don't know how to do it."

One question many investors will ask is the origins of the seemingly arbitrary holding period, from 7 to 1,000 days after companies go public.  The seven day waiting period is easy to understand, as IPOs can fluctuate wildly when they initially come to market.  But why 1000 trading days? 

"Academically, you find that the first four years of trading, IPOs are different from other equities," said Schuster. "After 4 years, they are more like the market.  Moreover, if you define an index with 250 or 500 trading days, you don't get the performance, and instead you get huge turnover in the index." 

IPOX Partners With S&P To Launch European Indexes

In related news, IPOX and S&P extended their existing partnership on the U.S. IPOX indexes to launch a new suite of indexes cover Europe.  As in the U.S., IPOX Schuster has formed three indexes to slice the IPO market into three distinct groups: The IPOX Europe Composite, IPOX Europe 100 and IPOX Europe-30. There is no word yet on investable products for those benchmarks.

S&P's Custom Indices group will calculate the indexes in real-time for IPOX-Schuster, as it does with the U.S. counterparts.

"Companies, like IPOX, are increasingly turning to Standard & Poor's for its proven ability to independently calculate real-time, custom indices," says Tim Eisenhauer, Senior Director at Standard & Poor's Index Services.  "Standard & Poor's extensive global market coverage provides us with the necessary means to calculate niche indices for any type of index strategy in any region of the world."

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