Alarm Bells Ringing For IPO ETFs?

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Includes: FPX, IPO
by: Zacks Funds

The IPO market stumbled in the beginning of 2016, with 1H16 being the worst first half of any year since 2009 in terms of the number of companies going public, as per Bloomberg data. In fact, "the number of domestic companies listed on U.S. exchanges is near its 2012 low," according to J.P.Morgan Asset Management.

The U.S. IPO space saw no activity in the first month of January and exhibited sluggishness afterward unlike the same period of last year.

Why Things are Uneasy in IPO Market?

The lack of enthusiasm among companies to go public is mainly due to the high cost of opting for an initial public offering [IPO], as indicated by the University of Florida. As per the institution, 'underwriting and registration costs are around 14% of the funds raised.' On the other hand, sponsors of companies are acting conservatively on IPO pricing, given the shakiness among investors, making the going-public initiative a costly affair.

Market turmoil since the start of the year and overvaluation concerns have also checked companies from indulging in IPOs. The year saw a chaotic start due to China and oil-led worries and after a shaky ride, it ended the first half with Brexit-blues.

Plus J.P.Morgan noted that "extraordinarily low borrowing costs means that the traditional avenue of issuing stock to raise capital is no longer the easiest, or cheapest, method." With ultra-low interest rates prevailing, companies now can borrow at much lower rates to fund their operations or refinance their debt.

If this was not enough, J.P.Morgan believes "the increasing regulatory burden on financial institutions engaged in IPOs, have led to a shift in how private companies realize their value." All these issues brought down the number of publicly-listed companies by 46% from the high of 8,025 in 1996.

Probably this is the reason why sought-after companies like Uber (Private:UBER), Airbnb (Private:AIRB), Palantir (Private:PALAN) or Snapchat (Private:CHAT) do not want to go public at this moment.

Trend in 2H

Still, things have improved a lot from the first half. Low pricing will probably hold the key as subdued pricing at times gives a big pop to shares on debut trading, going by a Wall Street Journal article.

Broader market also remained steady to start Q3 with the S&P 500 and Dow Jones Industrial Average hitting all-time highs. "Four companies are set to raise a combined $270 million" this week, as per Renaissance Capital, with biotech leading the way. In fact, biotech is the busiest industry on the IPO front this year, with 20 offerings year to date (36% of total). In the prior week, four IPOs raised almost $700 million.

So all in all, things may have started improving, but the undercurrent of the IPO market still seems to be slow. Below we highlight two IPO ETFs for investors who want to go deeper into the ETF world and follow the movement of these two funds.

First Trust IPOX Index ETF (NYSEARCA:FPX)

This ETF provides exposure to the booming U.S. IPO market by tracking the IPOX Global Composite Index. The index measures the average performance of U.S. IPOs during the first 1000 trading days. Currently, three firms - Facebook (NASDAQ:FB), Kraft Heinz Company (NASDAQ:KHC) and AbbVie (NYSE:ABBV) - dominate the fund's returns.

The product has a nice mix of sectors, with the top four being information technology, healthcare, consumer staples and consumer discretionary. It charges 60 bps in fees a year. Over the last one month (as of August 8, 2016), FPX added over 5.6%.

Renaissance IPO ETF (IPO)

This ETF follows the Renaissance IPO Index. Currently, the product holds 54 securities in its basket with the largest allocation going to Alibaba (NYSE:BABA) (10.30%), Citizens Financial Group (NYSE:CFG) (9.63%) and Synchrony Financial (NYSE:SYF) (8.47%).

From a sector look, technology stocks make up for one-fourth share while financials and healthcare round off the next two spots with double-digit exposure. It charges 60 bps in annual fees and added 7.2% in the last one month (as of August 8) against 4.1% gains offered by S&P 500-based SPY and 9.4% gains delivered by Renaissance International IPO ETF (NYSEARCA:IPOS). Original Post