Getting In on IPOs

There may be nothing in the investment field, short of one’s own portfolio’s performance, that generates more passionate and varied emotion than the topic of initial public offerings (IPOs). Some investors have had great experiences buying IPOs that have done well. Still others have bought IPOs that have not done well and want nothing more to do with IPOs. In general, IPOs are notoriously volatile. For clients who have not been able to get into enough IPOs on their own, or who want professional management of an IPO portfolio, there is a small mutual fund that invests in IPOs in the secondary market, the $17.6 million IPO Plus Aftermarket Fund (IPOSX).

In 2006 there were 198 initial public offerings in the U.S. that generated an average return of 26%, 12% of that in the aftermarket, according to the fund’s parent company, Renaissance Capital in Greenwich, Connecticut. While the number of IPOs that came to market in 2006 was only about 40% of the 486 companies that went public in 2000 and 49% of the 406 that went public in 2001, and there’s a “renewed interest in growth stocks,” Linda Killian, portfolio manager of the fund is not seeing the wild valuations and froth of the 2000, 2001, IPO frenzy. The deals “that are the priciest,” she says, are the new issues of the securities exchanges themselves, where “valuations are fairly hefty.” That, Killian explains, is because where there’s scarcity, as in the case of a finite number of exchanges, the companies can be more fully valued.

For 2007, Killian says she’s seeing more technology deals and fewer oil and gas deals, few retailers, and some more Chinese deals, some of which are more fully valued–again because of a relative scarcity of deals. According to its prospectus, the fund can hold up to 25% of its assets in foreign companies but there is not such limit on holdings of foreign companies that are registered with the SEC and listed on U.S Exchanges.

Killian selects which aftermarket IPO issuers to buy for the fund using a process that includes rating all the companies by how they fit into their industry. Are they a leader, first, second, or third tier? Are they growing faster or more slowly than their industry? Are company management’s interests aligned with shareholders’ interests? What’s their valuation versus their peers? Who is on their board? Does management own shares of the company and are they selling on the offering? Are margins in-line, better, or worse than the industry? She looks at growth rates and other metrics. Then each company gets a rating and a decision is made whether to include it in the portfolio or not. If a company gets a poor rating, she might even short it.