Initial public offerings (“IPOs”) have long captured the public’s imagination, as popular companies are suddenly available for purchase by anyone. After the dotcom bust cooled off the appetite for IPOs, the market experienced a resurgence in the mid-2000s with a number of popular tech offerings, including Google Inc.’s (NASDAQ: GOOGL) IPO in 2004. The IPO market continues to be fairly robust these days, with a growing number of tech and medical IPOs.
When investing in IPOs, investors may want to consider mutual funds as opposed to buying individual stocks, given the significant volatility and difficulty of acquiring shares in the offering.
Not All Are Created Equal
There are a number of different mutual funds that invest in pre-IPO shares, but their performance differs by a wide margin.
Renaissance Capital’s Global IPO Fund (IPOSX) invests in a portfolio of newly public companies at the time of offering and in post-IPO trading. As an actively managed fund, the team seeks to outperform the broader equity market utilizing their industry-recognized research. The mutual fund’s total returns have underperformed the S&P 500 every year over the past five years, with the exception of 2013 when it returned 51.74% compared to 32.39% for the benchmark index.
The T. Rowe Price New Horizons Fund (PRNHX) isn’t focused exclusively on IPOs, but invests in the common stocks of small, rapidly growing companies, which happens to include many IPOs. In the past, the fund has held pre-IPO shares in Twitter Inc. (NYSE: TWTR) and Facebook Inc. (NASDAQ: FB), which has helped it outperform the S&P 500 during four of the past five years and secure a five-star rating from Morningstar – a leading research group.
Investors looking for exposure to a specific IPO niche, such as healthcare, may want to consider the Fidelity Select Health Care Fund (FSPHX). While the fund doesn’t only invest in pre-IPO opportunities, the fund’s manager has become known for selectively investing in highly lucrative IPOs from the start. The mutual fund’s unique approach has single-handedly beaten its benchmark and the S&P 500 in each of the past five years.
Unique Risks to Consider
Investing in IPOs is risky business for individual investors, given the equities’ extreme volatility and the difficulty of securing shares at a reasonable price.
Mutual funds focused on IPOs diversify these risks by investing in many different IPOs rather than a single opportunity. While this approach enables investors to participate in the upside, they don’t have control over how long the shares are held by the fund. The Global IPO Fund, for instance, still holds 6.3% of its portfolio in Facebook shares, despite the company’s IPO occurring back in May of 2012 – more than three years ago.
These funds may also invest in IPOs that are risky in nature. For instance, the Global IPO Fund holds 4.62% of its portfolio in Alibaba Group Holdings Ltd. (NYSE: BABA), which has fallen more than 30% in 2015 due to China’s economic turmoil. Investors looking for exposure to Ferrari NV (NYSE: RACE) or other newer IPOs may also be saddled with these older and underperforming securities that can eat into their returns over time.
The Bottom Line
IPOs have become increasingly popular over the years, as individual investors look to own shares of the hottest new stocks. Unfortunately, investing in IPOs can be risky business for individual investors given the significant volatility and difficulty securing shares. Mutual funds offer a compelling alternative that’s more diversified in terms of risk, but the tradeoff is that investors may end up owning older and/or underperforming IPOs.
The best option may be investing in mutual funds that offer exposure to early-stage companies – including some IPOs – rather than focusing exclusively on them.