IPO Plus Aftermarket gives everyday investors a way in on a resurgent market for new shares. But this fund’s returns are as volatile as the stocks it buys.
By Timothy Middleton
January 13, 2004
When Internet search goliath Google goes public later this year, chances are you won’t be able to buy shares at the offering price. But you might get in via a mutual fund. IPO Plus Aftermarket Fund (IPOSX) already has its eye on what some are guessing will be the hottest Internet stock ever.
“Obviously we’re going to study this one,” says Kathleen Smith, one of the fund’s three managers, who spun it out of their work at Renaissance Capital, a specialist in initial public stock offerings based in Greenwich, Conn. “We know investors are going to be crazy about it.”
The lust for instant wealth, so recently tortured by the bursting of the Internet bubble, is stirring again. Last year only 68 companies went public, but their success was enough to take IPO Plus up 52.2%, nearly twice the market’s gain. This year, Smith expects at least 200 IPOs. In 1999, a record 486 deals were done.
(The first IPO of 2004 came Friday when K-Sea Transportation Partners (KSP) made its debut on the New York Stock Exchange. The company transports petroleum products by sea. It closed the first day of trading as a public company at $27.09, up 15.28% over its IPO price of $23.50.)
IPO Plus Aftermarket is the only mutual fund specializing in this market, and it benefits from the growing paucity of public information about new companies. In Wall Street’s deal with regulators over conflict-of-interest issues, it agreed to cut the link between investment banking and research, which has led to less analyst coverage.
Opening the window
A bull market opens the IPO window as surely as a bear market slams it shut. IPO Plus offers the opportunity to ride the crest of this wave, but it’s a dangerous ride. The fund was savaged in the bear market, tumbling more than 20% in 2002, 40% in 2000 and 50% in 2001.
Even for optimistic and aggressive investors, this or any other fund that invests heavily in IPOs is a trading vehicle, not a long-term holding. If I were to buy it, I would keep a mental 20% stop-loss order under it and flee when it hits the wall, as it inevitably will.
In the meantime, though, you can get the adrenaline rush of IPOs without having to slog through all those prospectuses.
Renaissance was formed in 1991 to capitalize on the wave of initial offers that swept the marketplace in the 1980s. It’s primarily a research firm, selling reports on new companies to institutional investors and sharing some with the public at its Web site.
The mutual fund was launched at the end of 1997, just in time to experience the best -- and the worst -- of the bubble. In 1999, it soared 115%. Assets peaked at $66 million that year and since have shriveled to $23 million.
A big difference
Smith says today’s IPO market is quite different than the heady market of 1999. Then, the average IPO surged 66% in its first day of public trading. Last year, the average deal rose 13% its first day. That’s considered normal; investment bankers usually leave a little money on the table, in the Street’s phrase, to create good feeling among shareholders.
Renaissance focuses its purchases on four areas:
Fundamentals, such as earnings growth and industry leadership.
Governance, seeking companies whose insiders retain substantial share ownership.
Valuation, or a reasonable price relative to earnings or cash flows.
Technical factors, such as the trading characteristics of a company’s industry.
Even with its small size, it can seldom buy more than 20% of its planned stake in any company at the IPO price. The balance of shares is purchased in the aftermarket -- hence the fund’s name.
In the case of Whiting Petroleum (WLL), which went public Nov. 20 at $15.50 a share, the fund’s average price in its position is $16.30 a share. The stock closed at $19.12 on Monday. Whiting is a small oil and gas producer spun out of Alliant Energy (LNT), a Midwest utility. “This is one of the first energy IPOs we’ve seen in a long time,” Smith says.
Seeking balance
The IPO market of the late 1990s featured predominantly technology companies. Today’s mix is more balanced. The fund’s current weighting reflects an 18% concentration in tech, 13% in financials, 11% in retailing and 8% in health care.
In this scandal-conscious age, it’s reassuring to discover that IPO Plus Aftermarket exhibits many of the attributes of “Clean Funds.” The IPO market is notorious for “flipping,” or selling shares quickly. To discourage rapid trading, the fund imposes a 2% redemption fee on shares held less than 90 days.
The fund’s three managers have heavily invested in it for their personal portfolios, together owning 5% of the fund’s shares. “Our policy at Renaissance Capital is that no one is permitted to invest in IPOs” outside the fund, Smith says.
But turnover and expenses at the fund are shockingly high. The expense ratio is 2.5%, easily 2˝ times the average for top-rated equity funds. Turnover is calculated by Morningstar to be 264%, meaning trading commissions and taxes on short-term gains are well above average.
Since I would expect short-term gains from this fund, however, these negatives don’t concern me too much. I’d ride a fund like this until the market told me its day was done.
What they’re buying
Black gold: Smith likes Whiting because it has solid management and good oil and natural gas assets. “We’re thinking production could grow (at a) 15% (rate), and cash flow should grow faster than that,” she says.
The money business: Also in November, the IPO fund took a position in Marlin Business Services (MRLN), which finances equipment leases for small business. The company came public at $14; the fund’s average price has been $15.45. It was at $17.48 on Monday. Smith expects bottom-line growth around 30%. “Banks have pulled in their horns in this area, so the market is there, and an improving economy and lower interest rates have benefited the company,” she says.
At the time of publication, Timothy Middleton didn’t own any securities mentioned in this article.