Courtesy of WSJ’s Chris Dieterich
The sprawling reach of exchange-traded funds has so far left initial public offerings virtually untouched, but the performance of the sole fund to focus on new stocks has proven worthy of investors’ attention – and could well encourage imitators.
The pioneering fund, First Trust US IPO Index ETF, tracks an index of 100 US IPOs and spin-offs developed by Josef Schuster, founder of IPOX Schuster LLC, an IPO research and investment firm based in Chicago. It climbed to an all-time high earlier in December, and has risen 26% in 2012 through Friday, towering over a 12% gain for the Standard & Poor’s 500. Over three years, the fund has returned 16% on an annualised basis, topping 10% for the S&P 500.
The fund’s year-to-date return is markedly better than if an investor was able to buy every IPO in the US this year at the offer price and hold it, a strategy that would have notched a 17% return through Friday, according to Renaissance Capital, an IPO research and investment firm.
The methodologies underpinning IPOX Schuster’s suite of indexes are, essentially, to focus on the biggest, brightest stars, skip the noise of first-day jumps or nosedives, and let the companies put their newly raised cash to work for a few years.
Data have shown the market performance of IPOs tends to trail shares of publicly traded companies with the same size by market capitalisation. In an April analysis, Jay Ritter, a finance professor at the University of Florida, found between 1970 and 2010, IPOs trailed peers by an average of 3.3% during five years after issuing shares, excluding the first-day gain.
But Schuster has found much of the lagging performance comes from a large chunk of small- and middle-capitalisation companies. “A few do extremely well, and the rest really underperform,” he said.
The fund is selective, only buys after a given stock has been trading for at least a week and then holds on to shares for several years. Many of its top holdings, which include spin-offs like Phillips 66 – up more than 50% since trading began in May – hardly resemble cash-hungry startups. Among the fund’s largest positions for most of the year: Visa, which went public in 2008, and General Motors, which went public in 2010 after the federal government bailed out the auto maker a year earlier. Visa, which this month was dropped from the fund after more than four years, has gained 46% this year, while General Motors added 37%.
Big holdings also include the likes of Facebook, which commands nearly 10% of the weight. Schuster added Facebook in late September, according to Morningstar, when shares prices hovered at roughly half of their May offer price. Shares have since climbed 20%.