New ETF of IPOs Is Better Than It Sounds: $IPO

barrons  Courtesy of Brendan Conway

A new exchange-traded fund that invests in newly public companies isn’t as speculative at it seems at first glance.

Almost every day, I get word of a shiny new exchange-traded fund for some ephemeral trend or market sliver. So when news of an ETF of initial public offerings crossed my desk—just in time for Twitter’s hotly anticipated IPO next month—I expected more of the same. But the fund turns out to be different from, and an improvement on, the clubby and nontransparent IPO market. Don’t hop on the bandwagon, but for the right sort of risk-taking investor, there could be an untapped opportunity.

It turns out the surest way of investing effectively in newly public companies—as opposed to speculating on a first-day pop in a stock—is making sure the company will still be selling goods and services a few years from now. University of Florida economist Jay Ritter found three decades of outperformance (1980-2011) in IPO stocks with the biggest sales revenues before they go public. If a company sells a lot of products, it’s certainly less likely to be a disaster. While this may sound obvious, it’s tough to put into practice. Small, newly public companies are tough to research and inherently risky investing propositions. They’re also not represented in the major stock indexes.ETFs by Category

SO BUYING THE LONGER-TERM IPO winners makes sense—providing you can spot them. It’s what Renaissance IPO ETF (ticker: IPO) attempts. This ETF, which launched last week with unusually heavy trading volume, isn’t about the first-day surge commonly associated with IPO investing. Its methods instead ensure a slew of promising revenue generators. The fund favors the biggest post-IPO stocks—they need at least $100 million in market value, though the great majority of current holdings are in excess of $2 billion. In all but the frothiest markets, that group should overlap with the high-revenue group. The ETF owns these stocks for a maximum of two years, after which point they begin to be adopted by major stock indexes, losing their status as “new” stocks. Top holdings include last year’s IPO disaster turned outperformer, Facebook (FB), plus Pfizer’s pet-and-livestock medicine spinoff Zoetis (ZTS), and restructured auto supplier Delphi Automotive (DLPH). The ETF will add the most liquid new stocks five days after they go public; the rest are added during quarterly rebalancing.

For the entire article from Barron’s and Brendan Conway, please click here