Some experts think that may start to change
By Ari I. Weinberg
This article is being republished as part of our daily
reproduction of WSJ.com articles that also appeared in the U.S.
print edition of The Wall Street Journal (September 5, 2017).
Index funds have made their presence felt in a big way in every
corner of the stock market except one: initial public
offerings.
What would it take to change that?
Only a limited number of index funds and exchange-traded funds
have moved to quickly include certain shares just after their IPOs
-- largely depending on the size and availability of the offering
and the size of the company.
By design, however, the freight train of assets that is still
moving into index funds tends not to find its way into shares
offered in IPOs. This is because, as their name implies, these
types of funds are built to track indexes, and indexes themselves
generally do not include shares of IPOs on Day 1. Stocks found in
indexes must fit established criteria for inclusion based on
metrics such as public float, geography, market cap, industry,
valuation and dividends.
IPOs, meanwhile, by their nature, involve companies that have no
trading histories and that tend to offer investors much less
information compared with more-established publicly traded
companies.
Index firm MSCI Inc., for example, generally requires at least
three or four months of trading before a new stock can be
considered for an existing or new index. There are exceptions.
Large stocks, based on relative market cap within a specific
segment, for example, can be included in an MSCI index as soon as
10 days after an IPO, with an announcement about the pending
inclusion made on Day 1 of the stock's initial offering if the
company is expected to meet market-cap and trading
requirements.
CRSP U.S. Equity Indexes, used by many Vanguard index funds and
ETFs, publishes similar criteria for both standard inclusion and
for "Fast Track" inclusion of IPO shares, as do S&P Dow Jones
Indices and FTSE Russell, among others. Index methodologies usually
include an annual or semiannual "reconstitution," wherein eligible
stocks are swapped in (or out) based on published criteria. IPOs,
including splits and spinoffs, can be special cases for quicker
inclusion.
The existence of such index rules, however, hasn't barred all
index-fund managers from the new-issue market. For example, some
index funds can participate in IPOs or buy a stock before it enters
the index, should the manager deem it necessary for tracking.
Again, that would really only be the case for large, liquid IPOs,
including spinoffs.
Snap's 'no' vote
Recently, a possible sticking point for more inclusion of IPOs
in index funds emerged. In the IPO of Snapchat parent Snap Inc.,
the shares had no voting rights. While a handful of public
companies have dual-class shares that award supervoting to insiders
-- such as Alphabet, Facebook and several family-controlled media
companies -- Snap's IPO was the first to offer no voting shares to
the public.
After consultation with clients, index firms S&P Dow Jones
Indices and FTSE Russell said this summer that they would limit
inclusion of companies with dual-class shares in their indexes.
MSCI's consultation closed on August 31. In January, a coalition of
major investors, including index-fund giants BlackRock and State
Street Global Advisors, called for a ban on dual-class stock.
So far, major players directly involved in the IPO market,
including startups, investment professionals and regulators, aren't
pushing for IPO shares to be included in index funds from Day 1, in
part because there is less IPO activity in general these days.
In addition, startups have many other attractive options for
attracting investment these days. Some argue that for company
founders and early investors, the benefits of being a public
company have receded in comparison with the massive increase of the
private capital markets, including venture capital, private equity,
sovereign wealth and family offices.
Change coming?
Some market professionals believe the limited presence of IPOs
in ETFs could change. For instance, more index funds could decide
to buy IPOs sooner than their current rules allow, or index
providers could systematize a process for both broad-based and
sector index funds to participate at the onset of a new issue.
ETFs designed to invest in IPOs have had a mixed record. These
rules-based funds aren't as strict on index inclusion for new
issues as the institutional index firms -- MSCI, FTSE Russell,
S&P Dow Jones and CRSP -- which are mindful of the trillions of
dollars of investor money that tracks their indexes or uses them as
benchmarks. Including an IPO on the first day of a listing, or very
soon after, could push a torrent of money to a stock that doesn't
have the liquidity or capacity to support it.
The $14.4 million Renaissance IPO ETF (IPO), which can hold IPO
shares as soon as five trading days after listing and until their
500th trading day, has experienced $19.2 million in outflows since
its late 2013 launch. The performance demonstrates the challenge of
investing in IPOs. It has underperformed the Mid-Cap Growth
category on a three-year annualized basis (a return of 4.7%
compared with 6.9%), but is up 26.8% this year compared with 13.7%
for the category, says Morningstar. It has a 0.60% expense
ratio.
The $860 million First Trust US Equity Opportunities ETF (FPX)
tracks the IPOX 100 index of the largest new offerings over their
first 1,000 trading days. According to Morningstar, the 11-year-old
fund has outperformed Large-Cap Growth over the past 10 years
annualized, 11.1% compared with 7.9%, but has underperformed in
2017, 14.1% compared with 18.2%.
Both managers also offer IPO ETFs for non-U.S. securities. First
Trust International IPO ETF (FPXI) has just $20.6 million in assets
and Renaissance International IPO ETF (IPOS) has $2.3 million.
Mr. Weinberg is a writer in Connecticut. He can be reached at
reports@wsj.com.
(END) Dow Jones Newswires
September 05, 2017 02:47 ET (06:47 GMT)
Copyright (c) 2017 Dow Jones & Company, Inc.
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