The IPO market in 2014 has been crowded, and IPO ETFs are among the best way for investors to get in on the action.
So far, 35 companies have hosted initial public offerings through the first three weeks of February. That's up 75% from the same period in 2013.
In total, 51 companies have filed for IPOs in 2014. That's an increase of 143% compared to the first two months of 2013.
And there have been some big gains for investors who have gotten in on winning IPOs early.
According to research from Renaissance Capital, 19 healthcare companies have gone public in 2014, and they've averaged first-day returns of 21%. The average total return for those companies so far is 41%.
And that's only one-fifth as much as the biggest gainers...
Dicerna Pharmaceuticals Inc. (Nasdaq: DRNA) on Jan. 29 captured a first-day return of nearly 207%.
But for every IPO that goes gangbusters, there are IPOs like Eagle Pharmaceuticals Inc. (Nasdaq: EGRX), which dropped nearly 15% on Feb. 11, its first day of trading.
Predicting which companies will hit the ground running and which companies will just hit the ground can be difficult, and it isn't the only challenge for retail investors in the IPO market.
Investing in IPOs: An Insider's Game
As Money Morning's Defense & Tech Specialist Michael Robinson has pointed out, the IPO market can be extremely difficult to break into for common investors, unfortunately.
"As I often tell people, because Wall Street tends to reserve the hottest issues for its 'best' customers - folks I often describe as the 'ultimate insiders' of the U.S. financial markets - IPO deals can be tough for retail investors to get into," Robinson said. "And even if you do manage to get a few shares, there are still difficult decisions to make - such as how long you should hold on, or under what circumstances you should sell."
That leaves investors jumping into an IPO the moment it goes public. The problem is, when a stock opens up 100%, that's where the investor is buying in. When it pares gains and finishes the day up 50%, the investor has just lost 50% of their original investment.
And those "ultimate insiders" are left celebrating their 50% gains.
Investing in IPOs doesn't always have to be risky, and the gains aren't reserved just for the "ultimate insiders."
Here are two ways any investor can play the IPO market, with IPO ETFs.
Two IPO ETFs for Trading the IPO Market
The First Trust IPOX-100 Index Fund (NYSE: FPX) generally invests in mid-cap firms with an average market cap value of around $3.3 billion. Rather than invest in micro-caps and other flashy IPOs, FPX managers only invest in an IPO after thoroughly researching the company's financials.
FPX, created in 2006, aims to avoid the early share-price rise and fall that can trap some investors. It aims to correspond to the performance of the IPOX-100 U.S. Index, which measures the performance of the top 100 companies ranked by market cap in the IPOX Global Composite Index. The global index only includes a stock after it has been trading for at least seven days and removes a stock on its 1,000th day of trading.
That strategy allows investors and fund managers to avoid all the volatility that occurs when a stock hits the market. Investors probably won't lock in the triple-digit gains some newly public companies post, but they will also be protected against IPO duds.
The biggest holding for FPX is Facebook Inc. (Nasdaq: FB) which accounts for 12% of the firm's weighting. FB's IPO was tumultuous, and the stock dipped 25% in its first two months. FPX played that one perfectly, however, buying in after the stock had been trading for four months.
Since the time FPX bought in, FB has gained nearly 223%.
FPX has posted a gain of 43% in the past 12 months. In 2014, the stock is up more than 5%, and it trades around $47 today.
Another play is the Renaissance IPO ETF (NYSE: IPO), which has only been around since last October. In that time, the fund has gained nearly 14%. It's up 6% in 2014. Currently, shares of Renaissance trade just over $23.
According to the fund, it holds only the largest and most liquid newly listed U.S. IPOs. Stocks are only added to the portfolio after they have traded for at least five days and are removed after two years.
More than 70% of the stocks owned by Renaissance are large caps, and mid-caps represent 28% of the firm's holdings. That minimizes the risks associated with small-cap IPOs, which tend to be more volatile.
Close to 31% of the fund's holdings are in the tech sector, with financials accounting for 20% and oil and gas companies taking up a 13% chunk of IPO's holdings.
Do you invest in IPOs? What IPOs have caught your eye in 2014? Tell us on Twitter @moneymorning using #IPO.
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