Alibaba IPO: Examining The Risk

Jul.30.14 | About: Alibaba Group (BABA)

By Michelle Jones

Alibaba's (NYSE:BABA) initial public offering is expected to be one of the biggest ever. As a result, investors have been running a lot of different models in order to best estimate what the Chinese online retailer might be worth. From FactSet, Portfolio Analytics Vice President Andrew Kovacs took a closer look at the potential risk associated with getting into Alibaba early.

Including Alibaba in risk models

He notes that not all companies that hold offerings are automatically included in risk models, but that Alibaba will probably be included because it will likely pass all the filters. Of course, the problem with creating a risk model for Alibaba is that there isn't enough historical returns. Those who still wish to build a model, however, could use some logic to determine what it might look like and then calculate the risk. The other option is to wait for more historical data.

Kovacs said it might not take too long for Alibaba to be included in a risk model. Regarding the ones that are on FactSet, he said it depends on "their frequency and the approach used to ad coverage." Some models are updated daily, and the initial risk could be created by the end of the IPO date. For those who rely on data from past returns, he said it could be as long as two or three weeks after the IPO.

Comparing Alibaba's IPO to Facebook's

As a point of reference, he examined Facebook's (NASDAQ:FB) IPO, which also was highly publicized ahead of time. He showed how the total risk and the specific risk climbed over time. One of the two models was calculated daily, while the second was calculated monthly.

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He found it interesting that both models showed how quickly Facebook's total risk climbed right after the IPO. He also said that both models were very wrong in determining the true risk of investing in Facebook early.

Looking at GM's risk model

He examined General Motors' (NYSE:GM) risk models as well, and they show an entirely different story. It looks like both of these models slightly overestimated the automaker's risk early on, although the changes were more gradual than Facebook's.

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Why does this difference matter for Alibaba?

So, when determining the risk associated with investing in Alibaba, it's important to realize that all models are just models. As a result, they have the potential to be very wrong, as they were in the case of Facebook. However, GM had a previous history as a public company, whereas Facebook did not, which is probably why the model was so much closer.

At the end of the day, he said any risk model developed for Alibaba is only as good as the data that is used to build it. As a result, he said adding coverage for new stocks early doesn't necessarily matter, particularly for those who manage a fund that replicates one of the indexes. Those who take a more active approach might find a model more important, but they should understand that any risk model that's developed for Alibaba could be very right or very wrong.

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