ETFs and Initial Public Offering Investments - dummies

ETFs and Initial Public Offering Investments

By Russell Wild

Want to take a real joyride? In 2006, First Trust Advisors introduced the First Trust IPOX-100 Index Fund (FPX). You can invest in an ETF that, according to the prospectus, tracks the 100 “largest, typically best performing, and most liquid initial public offerings” in the United States.

Just prior to the introduction of the fund, the index on which it is based clocked a three-year annualized return of 33.74 percent. Needless to say, with that kind of return, this new ETF got the attention of a good number of investors.

Those who jumped on board didn’t exactly have a smooth ride. When the market tanked in 2008, FPX lost 43.79 percent — almost 7 percentage points more than the S&P 500 lost. But in 2009, this fund gained 44.56 percent, and it has continued to outperform the broad market.

Thinking about plunking some cash into FPX? The future may bring more extreme volatility.

The rollercoaster of recent IPO ETF performance

When times are good for small and mid cap stocks, as they were in the three years prior to the launch of FPX, times are typically very good for IPOs. But when times are bad, you can guess what happens.

The index on which this ETF is based suffered terribly during the bear market of 2000, 2001, and 2002, with respective annual dips of –24.55 percent, –22.77 percent, and –21.64 percent. (If you started with $10,000 in 2000, you would have been left at the end of 2002 with a rather pathetic $4,566.04.)

A broader look at IPO ETFs

But what about the very long-term performance of IPOs? Jay Ritter, a professor of Finance at the University of Florida, keeps copious records on the returns of IPOs. Dr. Ritter asserts that, collectively, they haven’t done all that well vis-à-vis the broad market.

But he hastens to add that long-term performance is dragged down by the smaller IPOs, and that larger IPOs — the ones included in the IPOX ETF — as a group have modestly outperformed the market, albeit with greater volatility.

Indeed. As the IPOX Index now stands, tech stocks, volatile as heck in their own right, make up slightly more than 25 percent of the roster. The top three companies together represent nearly one-third of the index’s value. Do you really want that kind of swing in your portfolio, on top of an expense ratio of 0.60 percent?

Maybe you do. But if you are inclined to take such a gamble, please don’t do it with any more money than you can afford to lose. Of course, that’s true of all stocks, but especially of these youngsters.