It sure looks tempting. After a very long dry spell, companies are finally lining up to sell stock to the public for the first time. And of course, there’s an exchange-traded fund ready to scoop up those shares, with another on the way.
When the market is uncertain, few companies are willing to go public. But after months of virtually no activity, 12 firms have gone public since April 1, with 70 more in the pipeline. If the markets continue to improve, says Morningstar analyst Bill Buhr, “you could see the dam burst.” These initial public offerings are among the sexiest of investment options (one word: Google). Plus, they tend to outperform in down or uncertain markets, when the initial share price tends to be much more conservative and there’s more potential for big gains. But beware the “lottery effect,” says Larry Swedroe, director of research for Buckingham Asset Management: “Very few IPOs provide those outstanding returns.”
What’s more, trying to win that lottery through an ETF can be a long shot, experts say. ETFs offer diversification, since they hold multiple stocks, but that isn’t always a good thing. The First Trust U.S. IPO tracks the IPOX-100 U.S. index, which is made up of 100 IPOs with the biggest market capitalization. But diversification dilutes the impact of exceptional performances. For example, Visa’s stock rose 24 percent in the first three months it was eligible for the index, but the ETF rose just 10 percent; this year Visa’s performance has been triple the ETF’s. “No basket of securities is going to have the growth potential that a single stock will,” says Eric Anderson, an analyst at First Trust. “The flip side of Visa can easily happen.” Diluted impact could be an even bigger issue if plans go through to base an ETF on the new FTSE Renaissance IPO index, which includes all new offerings. Jerry Moskowitz, president of FTSE Americas, declined to comment on that, but acknowledged the firm is currently negotiating with ETF providers.