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Do You Need The IPO ETF In Your Portfolio?

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With the markets seemingly slumping as we head into the fourth quarter, some reevaluation of portfolio allocations is probably a good idea. This is especially true this time around, as the U.S. no longer seems to be such a safe haven compared to the rest of the world.

Still, the American market is arguably the best of the worst among the large nations, as Europe appears to be plunging back into crisis mode, Chinese concerns are back at the forefront, while Japan and other Asia-Pacific economies seem mired in low growth environments, at least for the time being.

Due to this, a focus on the U.S. probably isn’t a bad idea at this time, especially as the presidential election removes some uncertainty and the fiscal cliff hopefully gets resolved. However, a general broad market approach may not be the best way to attack the problem, suggesting that many investors could be better served by targeting a specific corner of the investing world (read Three Outperforming Active ETFs).


Although Facebook (FB - Free Report) hasn’t exactly performed well in light of its recent Initial Public Offering, the trend still suggests that many IPOs perform quite well immediately following their debut on the stock market. That is because IPOs generally seen a nice bump on their debut offering while more ‘mom and pop’ investors are now able to pile into a stock and push demand and thus prices higher in a particular security.

Furthermore, many IPOs are priced rather low so that investment banks can easily sell shares of the underlying firm while also avoiding a ‘busted’ IPO in which the stock fails to trade in the positives for the day. This practice can thus usually help create stronger performances in the medium term as well, especially in stocks that have shown solid levels of momentum or in firms that are continue to generate impressive amounts of investor interest.

With this backdrop, investing in IPOs could be a good idea despite some of the recent troubles the space has seen. After all, Google has added close to 600% since its initial offering, while Visa has added close to 50% since its debut in early 2008, while Michael Kors Holdings (KORS - Free Report) has added over 110% since its first appearance less than a year ago (see Five Top Performing Single country ETFs of 2012).

Yet, as we have seen as of late, for every GOOG there is usually an FB as well, suggesting that investing in just one or two IPOs could produce subpar returns. Due to this, an ETF approach targeting the IPO market could be the way to go, as it spreads out assets across a variety of firms, hoping to take advantage of a broad positive trend in the IPO space, instead of worrying about company specific problems.

For these investors, a closer look at the First Trust IPOX-100 Index Fund (FPX - Free Report) could be warranted. That is because this fund selects, using a modified value-weighted price system, a basket of 100 stocks that have had their initial offering with the past 1,000 trading days.

The ETF utilizes a quantitative approach in order to select the securities for the basket, while also putting on a 10% cap on all constituents. The fund is rebalanced on a quarterly basis and will generally consist of the 100 largest, typically best performing, and most liquid IPOs that are in the IPOX Global Composite Index (also read Three Biggest Mistakes of ETF Investing).

This approach looks to give investors broad exposure to a wide variety of firms that have recently had their initial offerings, potentially acting as a lower risk way to play the often uncertain IPO market. In fact, according to First Trust’s website, the PE for the basket comes in at 16, the P/B is under 2.5, while the price/sales ratio is below 1.0, suggesting decent value in the holdings despite the growth metrics that are usually prevalent in the IPO space.

Currently, the product also has a nice mix of sectors, with three comprising at least 20% including energy, technology, and consumer cyclical. Furthermore, although large caps make up just over half of assets, mid caps (25%) and small caps (20%) also receive big chunks as well (see Three Impressive Small Cap Dividend ETFs).

In terms of individual holdings, Visa (V - Free Report) takes the top spot right at the 10% limit while (FB - Free Report) and (GM - Free Report) round out the top three. Beyond those securities, a group of energy names rounds out the next few securities, although assets seem to be well spread throughout the 100 names in the product.

While the fund is somewhat expensive considering its focus, fees are 0.6% a year, volume is also quite poor, suggesting wide bid ask spreads. Furthermore, many of these fresh IPOs do not pay much in dividends, so the paltry 30 Day SEC yield of under 0.5% could be a disappointment to some.

Still, despite these drawbacks, the fund really shines when compared to the broad competition, the S&P 500 index.  Over the past five years, FPX has gained about 17.5% compared to a -4.7% loss for SPY (also read Five Best ETFs over the Past Five Years).

Shorter time frames are more favorable to the S&P 500, but the IPO-based fund still wins in performance when looking at a one year (FPX outgains by 350 basis points) and a year-to-date look as well (nearly 450 basis points).

So while FB may be dragging down the perception of the broad IPO market, the segment is still going strong when you take the whole sector into focus. For this reason, investors shouldn’t get too bogged down with one or two weak performers in the IPO market, and should instead look to FPX as a solid outperforming fund that can not only provide exposure to initial public offerings, but can beat out traditional benchmarks by a pretty wide margin as well.

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