First Trust’s US IPO ETF proves a persistent outperformer

Oct 11th, 2017 | By | Category: Equities

Blockbuster performance from a number of new listings in the US market has translated into impressive returns for the First Trust US IPO Index UCITS ETF (FPX LN, FPXU FP), a London- and Paris-listed ETF providing exposure to US IPO and spin-off stocks.

Josef Schuster - IPOX

Josef Schuster, founder of IPOX Schuster.

Holdings such as Kite Pharma, Chemours and PayPal, up 301%, 148% and 73% year to date respectively, have helped the ETF outperform the S&P 500 by 4.6% so far this year.

But this is no flash-in-the-pan performance. The index underlying the ETF, the IPOX-100 US Index from boutique index provider IPOX Schuster, has delivered an annualised excess return of more than 4% per annum over the past 10 years versus the S&P 500.

With this kind of persistent outperformance, it’s no surprise that this innovative ETF from London-based First Trust Global Portfolios is increasingly on investors’ radars.

So what’s the story behind the strategy?

IPOs are often the subject of high interest for investors and the media alike. Much of the focus, however, is on how the stock performs in the first few days and weeks of its listing. IPOs can be a risky investment during this period, due to the lack of financial information with which to value the company and the non-existence of past trading data. However, on the other hand, IPOs are a fantastic play on innovation and growth.

Considering there are around 120 IPOs and spin-offs a year in the US, keeping up with all the action can be tricky for investors, which is why investing in a fund can be a great resource for those who want broad access to this thematic play. Holding a basket of recent IPOs and spin-offs also diversifies the risk of company-specific events and negative individual performance.

[pullquote]“IPOs and spin-offs are often a pure proxy for innovation and economic growth”
– Joseph Schuster, Founder, IPOX Schuster.[/pullquote]Indeed, according to Joseph Schuster, an authority on IPOs and the creator of the index, “indexing IPOs and spin-offs as applied in the pioneering IPOX-linked First Trust US IPO ETF has shown to be particularly effective in mitigating stock-specific risks of the sector, often a pure proxy for innovation and economic growth.”

Launched in August 2015, on the back of a hugely successful US-listed version of the fund, the ETF provides investors with exposure to 100 US equities that have been listed in the last four years via an IPO or by being spun out of an existing company.

Equities enter the underlying index on their sixth trading day and exit 1000 trading days (four years) thereafter. The entry point is timed to avoid the increased volatility often seen in the first few days of IPO trading. The four year exit mark is the result of extensive back-testing analysis by Schuster that showed to be the optimal holding period.

During his research, Schuster also found the subsequent performance of newly listed IPO stocks was dependent on their initial market capitalisation. Large- and mid-cap stocks tended to outperform small- and micro-cap stocks over the four-year holding period. Schuster subsequently designed the index to take advantage of this trend, with the index titled towards large-and mid-cap stocks with substantial liquidity. The largest constituent is capped at 10% and the index is rebalanced quarterly to minimise transaction costs.

Currently, the largest index constituent is AbbVie, a pharmaceutical company created in 2013 as a spin-off from Abbott Laboratories. Since it has been four years since its initial listing, AbbVie will drop out of the index at the next quarterly rebalance. The next largest constituents are Kraft Heinz with 8.4%, Paypal with 6.8% and Shire with 4.1%.

The index has more concentrated exposures than market cap-weighted benchmarks, although Schuster points out that sector diversification is not the aim of the index. Information technology is the largest sector with a 35.2% weight, followed by health care with 21.1%, consumer discretionary with 17.3%, and consumer staples with 13.4%. All other sectors represent less than 10% weight each.

In the US, the NYSE-listed version of the ETF has more than $875 million in assets under management. The European-listed counterpart is just gaining traction with around $7 million in assets, but given the strong performance, the smart money will likely follow.

The ETF has a total expense ratio of 0.65% and, according to Derek Fulton, CEO of First Trust Global Portfolios, “is a great example of how the ETF wrapper can help investors gain exposure to more innovative and granular sources of return and diversification.”

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