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What to do when your client is IPO crazy

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Lyft, Uber, Pinterest, Slack: Some well-known companies have listed or will list their shares on public exchanges for the first time this year. With frequent media coverage of the offerings, it’s understandable some advisors’ clients will want to get in on the action.

The only thing that might match the clamor for a shiny new stock is the reluctance of advisors to indulge their clients’ requests to buy into the offering — at least in the way the clients want them to.

Advisors say their caution is well founded. Between the overall difficulty of stock picking, the sometimes low performance of stocks following their IPOs, the incentives of those initially selling the shares and the lack of knowledge clients generally have about the companies they’re interested in, the enterprise is much more likely to go poorly than well, say several advisors who were surveyed about their own experiences with client requests about IPOs.

“It’s kind of a roulette table,” says advisor Eric Walters, founder of SilverCrest Wealth Planning. "Is it possible Slack is going to be the new Facebook? Yeah, maybe.” But consider the IPO-tracking ETF from Renaissance Capital, he says. It has underperformed the S&P 500 at most milestones in its first decade.

As a class of investment, IPOs are riskier and less likely to outperform the market, he says.

To be sure, a newly public company can perform well. Shares of Pinterest, which launched its IPO on April 18, gained 27% in its first eight days of trading to close at $30.98. They can also fare poorly. Lyft's share price shed nearly 24% in its first month of trading, closing at $59.80 on April 30.

Frequent coverage from media outlets such as CNBC and Bloomberg has fueled clients’ interest, veteran advisors say.

The “popular press now seems to be more aggressive,” says Avani Ramnani, director of financial planning and wealth management at Francis Financial, though she has seen it throughout her 17 years in the industry.

Ashley Folkes, an advisor at Moors & Cabot, says clients’ desire to get in on high-profile IPOs has been a constant during his long career. "I've had this question posed to me a couple of times a year for the last 20 years,” he says.

So how do advisors steer clients away from what could be a poor investment decision? Carefully, they say. Here are some of their strategies:

Educate clients on the odds
While Folkes will not deny investors the chance to invest in an IPO, he does educate them beforehand.

“You very rarely can beat the market as a whole” picking IPOs, he says, and it’s difficult even for professionals.

Once a stock is on the market, the rush of buyers and sellers makes it hard to get an edge, says advisor Rob Greenman of Vista Capital Partners. With so many trades taking place, he says, the market sets a fair price very quickly.

Get clients to reflect
Greenman sees it as his role “to remove emotion” from the investment decision. “While it might be tempting to find the needle in the haystack,” he tells clients, “why don’t we just own the haystack” by investing in a broad range of stocks?

Folkes finds that asking basic questions about the IPO puts clients in a different frame of mind. "Have you studied their balance sheets?” he’ll ask. “Do you know their risk analysis?"

“Don’t buy [a stock] because it’s an IPO,” he tells them. “You buy it because you believe it's a good investment and you believe in the company and you believe in the company's future."

Understand their motivations
When a client asks him about an IPO, advisor Mitchell Kraus, co-founder of Capital Intelligence Associates, tries to find out what’s behind their question. Do they want to get rich quick? Do they see the stock as a good deal? Or is it something else? “If you figure out what their motivation is,” he says, “it’s possible there are other ways to achieve that” without the risk of investing in an IPO.

Encourage them to wait
Because insiders cashing out stock will drive the price down, says Walters, and because there is little data to evaluate the company, try to convince clients that they should wait 12 to 18 months to invest. By that point, he says, many clients will have lost interest or, if they are still following the stock, they will likely have seen its value fall. “Usually they’ll draw the conclusions themselves,” he says. And if they are still interested in buying, they will have many quarters of data to inform that decision.

Set money aside
If a client insists on investing, Ramnani says advisors can open a so-called Fun Fund: a separate account with a set amount of money where, "if that amount goes to zero, it has absolutely no impact on our client's long-term security." Even for clients with millions invested in the market, she does not recall seeing a Fun Fund with more than around $70,000 to invest.

Clients understand why they shouldn't have too much exposure to any single security, she says. “They just want a part of the action.”

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