First Trust introduced the first exchange-traded fund to track U.S. initial public offerings last week, but investors should think carefully about when they choose to buy in, according to MarketWatch columnist Mark Hulbert.
The fund, called First Trust IPOX-100 Index fund and launched on the American Stock Exchange last Thursday, picks 100 stocks from the IPOX U.S. Composite Index, which includes IPOs in their first 1,000 days of trading. The Lisle, Ill.-based company's ETF only picks stocks after they have traded for seven business days, in order to avoid the immediate swings new stocks often experience, according to Dan Waldron, First Trust vice president for ETF product development.
Finance academics in the past often considered IPOs bad bets in the long run, according to Hulbert. Not only are they pricey, he points out, but "when measured from more realistic prices that would be available to the individual investor--such as the close of the first day of trading in the after market--the average IPO lags the market for several years after going public," wrote Hulbert.
"If this were the state of the debate today, one would have to advise against investing in the First Trust IPOX 100 Index Fund. Its existence would have to be chalked up to a cynical attempt to earn management fees at the expense of a gullible public," he wrote.
But research from Jay Ritter, a finance professor at the University of Florida, indicates IPO success is often related to the company's revenue in the year before going public.
Because IPOs do best when the small-cap growth sector is performing best, Ritter compared the each IPO to established stocks for companies of similar sizes, where the larger IPOs--the type most likely to be in the top 100--beat their established stock counterparts by 10%.
This means that the IPO ETF will be most beneficial to investors in times when the small-cap sector is leading the market, according to Hulbert.
The staff of Money Management Executive ("MME") has prepared these capsule summaries based on reports published by the news sources to which they are attributed. Those news sources are not associated with MME, and have not prepared, sponsored, endorsed, or approved these summaries.