H&Q Enters the Not-So-Crowded Field of IPO Funds

Hambrecht & Quist's quant-driven portfolio will be only the second pure-play IPO fund.
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Though the market for initial public offerings is red hot, IPOs have never been a sexy objective for mutual funds.

Can

Hambrecht & Quist

change that? The big San Francisco underwriter starts peddling shares of the H&Q

IPO Discovery

fund at some point in September or October.

H&Q, of course, is known for new stock issues, not new mutual funds. But it's not a complete neophyte when it comes to mutual funds -- its

H&Q Capital Management

runs two closed-end funds that invest in health-care stocks. Newly created

H&Q Fund Management

will run the company's first open-end fund.

Incredibly, considering the appeal of the new-issues market these days, the IPO Discovery fund will be only the second pure-play IPO fund to hit the market. The

(IPOSX)

IPO Plus Aftermarket fund, run by

Renaissance Capital

, made its debut in December of 1997.

First, some specs for the H&Q fund: There will be three classes of shares, including a no-load class with a 1.5% expense ratio. Minimum investment: $5,000; $2,000 for retirement accounts.

The fund's mission, according to David Krimm, president of H&Q Fund Management, is to open up the IPO market to the little guy and to make it easier for IPO investors to diversify their holdings. The fund might own 100 to 200 new issues, he says.

But which ones? Do you picture an army of financial Lewis and Clarks, fanning out across the country, scouting undiscovered businesses before they're charted on the map? Picture a bank of PCs, instead. This fund will make its buy -- and more importantly -- its sell decisions based on reams of quantitative data, sifted, sorted and processed by the fund's subadviser,

Symphony Asset Management

.

Symphony, another San Francisco group, manages some $3 billion in private accounts, as well as a couple of other quant funds,

(ASMCX)

Accessor Small to Mid Cap Portfolio and

(SWANX) - Get Report

Schwab Analytics.

"Our strength is working our way through volumes of data and whittling that to a clear and concise signal," says Neil Rudolph, Symphony's chief operating officer. Symphony will look at every IPO from the top 30 underwriters, says Krimm, and base a buy decision on the size of the offering, the market cap of the issuers, the percentage of insider selling and other factors. When it can't get an allotment, the fund will consider buying shares in the aftermarket, based on price performance, analyst ratings, valuation relative to the industry and insider activity.

Symphony considers any stock trading less than 18 months an IPO; it expects to sell most of its holdings within a year. (Needless to say, this is a fund best for tax-deferred accounts, unless you have a special fondness for capital gains.) In order to stay nimble and not affect the price of the shares it's trading, the fund says it will close if and when assets reach $300 million.

Despite its parentage, the IPO Discovery Fund won't have an automatic in when it comes to IPOs underwritten by H&Q. In fact, because of conflict-of-interest issues, the fund can't buy from H&Q. Not to worry, though, the fund can ask for an allotment from other syndicate members. Companies usually have multiple underwriters when they go public.

H&Q's quantitative approach is almost 180 degrees from that taken by the managers of the IPO Plus Aftermarket fund. The firm is primarily a fundamental shop, and it has been an IPO research specialist since 1991. The competition's performance record is short and choppy -- like the IPO market -- but impressive. The IPO Plus Aftermarket fund is up 33% so far this year on top of an 18% gain last year. During last year's calamitous third quarter, the fund plunged 24%.

Rocky, yes, but IPOs are undeniably lucrative for those with a strong stomach. The

Bloomberg IPO Index

, which tracks stocks in their first year of trading, is up some 611% in five years compared with a 192% rise of the

S&P 500

and a 80.9% gain for the

Russell 2000

.

There are other funds stuffed to the gills with IPOs (see below), but unlike the pure plays, these funds have no mandate to be all IPO, all the time.

So here are the questions I keep asking myself: Why, in a day when investors are literally suing their brokers because they can't get enough of IPOs, aren't there more IPO funds already? And why isn't the IPO Plus Aftermarket fund bursting at the seams? (The fund has pulled in just $15.6 million since inception.)

I think the answers have more to do with the human psyche than with marketing and distribution issues suggested by many of the gurus I asked.

I agree with

Morningstar

analyst Christine Benz: "Maybe," she theorizes, "the people who buy IPOs want to do it themselves." Bingo. Isn't it more fun to discover the next

Microsoft

(MSFT) - Get Report

or the next

MP3.com

(MPPP)

on your own, rather than be handed a whole bag full of companies from this year's crop of IPOs?

IPO mutual funds may indeed be the only ticket for many investors to the glamorous world of new issues. And their diversified, constantly weeded portfolios may also be the safest way to explore these risky investments. But what H&Q's new fund will have to prove is that it's just as fun.

Anne Kates Smith is a senior editor at U.S. News & World Report in Washington. At time of publication, Smith had no positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks or funds.