IPO ETFs Back in Focus as Public Offerings Attract 90% More This Year

Initial public offering exchange-traded funds are back in focus, as the U.S. market for IPOs is bouncing back compared with last year’s levels. 

U.S. initial public offerings have raised $6.7 billion so far this year, according to data from Renaissance Capital. That’s 90% more than was raised at this same time a year ago, and is just under 2022’s full-year IPO haul of $7.7 billion. 

Johnson & Johnson's spinoff of its consumer health division, Kenvue, account for the bulk of this year’s IPO numbers. Kenvue raised $3.8 billion last week in the largest IPO since 2021. 

Given the size of the company’s IPO, Kenvue isn’t necessarily a sign that the IPO market is headed back to the heady days of 2021. In that year, 397 IPOs raised $142.4 billion—the largest year for IPO proceeds ever, according to Renaissance data. 

2023’s IPO environment certainly looks better than that of 2022, the weakest year for proceeds in more than three decades, but it’s still a tepid year. 

Nevertheless, things are headed in the right direction, and investors considering IPO ETFs for the long term might actually benefit from a more muted environment in which new stock debuts aren’t bid up to the stratosphere. 

The Appeal of IPO ETFs 

The thesis behind IPO ETFs is easy to grok. If you could invest in the next Apple or Alphabet before it takes off or before it’s even added to the broad stock market indexes, it’d be a no-brainer to do so. 

Shares of Tesla soared more than 15,000% before they were added to the S&P 500 in late 2020. 

That’s essentially the pitch that Renaissance Capital, a provider of data on IPOs and the issuer behind one of the largest IPO ETFs, makes to investors. 

“The world moves faster than ever, yet most portfolios consist of older stocks. Our IPO ETFs hold innovative new stocks before they are added to core indices,” it says. 

To be clear, IPO ETFs don’t usually participate in IPOs themselves. They buy shares of newly public companies shortly after they begin trading on stock exchanges. 

That means they don’t participate in the coveted “IPO pop,” in which investors in an IPO are rewarded with quick gains. 

For these 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. Kenvue jumped 22% after its listing. 

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 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 to Consider 

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 Alphabet or Apple is seductive, so investors will almost certainly stay interested in IPOs. 

There are a handful of ETFs out there that hold shares of newly minted IPOs, including the First Trust U.S. Equity Opportunities ETF (FPX), with $740.5 million in assets under management, and the Renaissance IPO ETF (IPO), with $126 million in AUM. 

The smaller IPO ETF has done well this year, gaining 16%, just short of double the S&P 500’s 8.2% gain in the same period. The competing FPX hasn’t done as well this year: It’s up around 4% year to date. 

Long-Term Returns  

To be sure, returns over a four-month period don’t tell the whole story. It’s more informative to look at returns for these funds over longer time horizons. 

For instance, since its inception in October 2013, IPO is up 50%, less than the S&P 500’s 190% gain, and less than rival FPX’s gain of 110% in the same period. 

So, while IPO may be outperforming this year, FPX is leading the charge since 4Q 2013, and both are underperforming the S&P 500 since then. 

That said, it’s a completely different picture when you go back all the way to April 2006, when FPX made its debut. Since then, it’s up 363%, ahead of the S&P 500’s 351% return in the same period. 

The time period you measure impacts the returns you will see, but it certainly seems FPX has a superior track record compared with that of IPO, one that outpaces even the broader market. 

Still, past performance is no guarantee of future results. This year’s outperformance in IPO speaks to that. 

Focus on the Largest IPOs 
 
The wildly different portfolios of the two ETFs explain the differences in returns. FPX holds positions in the 100 largest recent IPOs, purchased after the close of the sixth trading day and held for approximately four years. 

The ETF captures “around 85% of total market capitalization created through U.S. IPO activity during the past four years,” according to issuer First Trust. 

The competing ETF, IPO, isn’t much different, in that it captures the top 80% of the market cap of new IPOs. It adds “sizable” IPOs on a fast-track basis, while other IPOs are added during scheduled quarterly reviews. 

Both ETFs’ focus on larger IPOs may be beneficial for their returns, as studies suggest companies with revenues exceeding $1 billion when they debut perform better over the long term. 

Big Differences 

Where IPO and FPX significantly diverge is their holding periods. FPX aims to own its stocks for around four years, while IPO kicks them out after two years. 

Another difference: While FPX will hold the stock of the acquirer or merged entity if that stock is acquired or merges with another, that’s something rival IPO won’t do. This resulted in some unusual names ending up in FPX’s portfolio, such as Baker Hughes, Dow and Cummins, among others—stocks of mature companies that have been around for ages and could hardly be considered fresh IPOs. 

Because of its more targeted exposure and shorter stock holding period, IPO gets the nod as the purer play on initial public offerings, even though its historical performance pales in comparison with FPX. 

Contact Sumit Roy at [email protected]