Everyone loves a good IPO story. Exopharm, up 175 per cent in the year of listing, last year, and Adriatic Metals, up 188 per cent. Then there was Ardea Resources the year before, up 850 per cent in the year of listing. But such sensational examples mask the real story across the IPO market.
According to a new study by Parametric, the implementation specialist manager, the relative performance of IPOs should only be assessed on the first day of trading, for starters, because investors can readily buy the stock as soon as it lists. The study also examines the hidden costs of excess brokerage paid by some fund managers to secure “generous” allocations in IPOs.
The authors of ‘Anecdotes Versus Evidence: The Institutional Case for IPO Participation’ are Parametric senior researcher Mahesh Pritamani, based in the Seattle head office, and managing director, research, Raewyn Williams, based in Sydney. They say, while leaving room for exceptions, their findings cast doubt on whether managers are really adding value to their super fund client portfolios by participating in IPOs.
“Even when the manager is highly skilled in selecting which IPOs to participate in or can secure a surprisingly generous allocation to new shares, it is difficult for IPO participation to add meaningfully to performance once all costs are factored in,” the report says.
“This takes much of the gloss off racy IPO anecdotes the industry loves to share and reveals a much more reliable, evidence-based alternative path available to a super fund: to pursue simple, nuts-and-bolts best execution and transactional efficiency, without favour or generosity to any particular broker.”
Examining all IPOs on the ASX between 2011 and 2018, and after informal interviews with eight global brokers, lead brokers and underwriters to IPOs, the costs relevant to the analysis are broader than many super fund investors may realise.
The main “hidden” cost is excess brokerage, rather than “execution only” brokerage, paid by fund managers – and passed on to their super fund clients – throughout their normal trading in order to develop a better relationship with certain brokers which they believe will give them more generous allocations in upcoming floats. The average brokerage in this regard, they believe and assume for their study, is 15bps compared with an execution-only average cost of 5bps.
The two ways to add value through IPO participation are stock selection, as with all sharemarket investing, and getting a “generous” allocation. For a super fund with a $2 billion Aussie equities portfolio and a 50 per cent annual one-way turnover, the difference in this “alpha-seeking” IPO strategy, which sees IPO participation as one source of alpha, and a best-execution strategy is paying $2-4 million a year in brokerage versus $1 million.
And, even if a manager shows skill in selecting the best IPOs or gets better-than-fair allocations, the gains from the strategy are tiny compared with all the other ways to add value to a portfolio. For instance, even assuming a very generous allocation of five times that of a “fair” allocation (as defined in the study) the average annual gain is only 12.5bps.
And one has to beware of averages. For instance, the best year for IPO one-day gains in the study period, 2017, showed an average gain of 11.4 per cent. But this included seven IPOs that doubled in price on listing and four which lost 25 per cent or more.
The authors say: “Managers’ advocacy must move beyond sensational anecdotes into a genuine assessment of IPO participation value that focuses only on the initial listing day, covers all IPO participation (no cherry picking), nets out explicit costs and speaks to the manager’s special selection and bookbuild allocation qualities.”