Should you invest in IPOs as a separate asset class? I'm getting these kinds of questions in the wake of the Twitter excitement. The answer is...maybe. It depends on what kind of investor you are.
First, you should know the basic rules of IPO investing. Here are mine:
- IPOs follow the stock market, they do not lead it. As a general rule, when the markets are doing well, IPOs will be doing well. If you believe, for example, that the S&P 500 is going to be up double digits next year, IPOs will likely be up and outperform that benchmark. The opposite is also true.
- IPOs are more volatile than the market. They have higher beta, in the parlance of the market. So what? It means if you are an investor that cannot stomach ups and downs, stay away.
- Follow the money. IPOs are The Church of What's Happening Now (apologies to Flip Wilson). There are trends in IPOs that change over time. There are sectors that get hot for a year or so, then die out as the space becomes saturated. If you want to invest in IPOs, stay with the hot sectors.
Here is what's happening now: social media, biotech/oncology, cloud computing, and internet security.
There are occasional outlier investment classes. One recent example is the success of a small group of specialty retail IPOs. Examples: Restoration Hardware (RH), Five Below (FIVE) and now, last week, the successful IPO of The Container Store (TCS).
But this is a small group. Stick with the big trends. Why? Because that's where the money is! If the money's not flowing in, who's going to carry you down the river?
So, is this the right time to invest in IPOs? Your view on where you think the market will be going over the next year is your primary guide. For the moment, there are some signs that the IPO market is looking toppy.
Here is what I see:
First, the main mutual fund that everyone watches, Renaissance Capital's IPO Aftermarket Fund (IPOSX), is up over 40 percent this year, handily outperforming the S&P 500's 24 percent gain, but it topped out almost a month ago.
Second, there's an ETF for IPOs. The very same Renaissance Capital has introduced the Renaissance Capital IPO (IPO) three days ago. This ETF holds most of the larger IPOs in the last two years; Twitter will go into it next Thursday. They will be the first ETF to own the stock. But the mere fact that there is now an ETF for this asset class--which means it is very easy to own--is an indication that interest is high in the IPO space.
Third, this is the biggest week for IPOs since at least 2007. 16 IPOs are pricing worth nearly $4 billion. Why go public this week? Blame the underwriters: You get the stuff out the door when you can. Markets are up. Let's get this stuff out the door!
Last, the IPO market has become choppy as IPO observers will readily tell you. Five of the six IPOs that began trading today are trading below their IPO price. This is likely partly due to the fact that Twitter is sucking the oxygen out of the IPO room, but still.
I'm not saying "market top," but you get what I mean.