An ETF Tracking the Hot IPO Market

NEW YORK (TheStreet) -- Over the weekend Barron's had a feature on what has been a hot initial public offering market. It noted the success of new companies including Noodles & Company (NDLS) and Tableau Software (DATA).

The First Trust US IPO Index Fund ( FPX) has been trading for seven years, has accumulated $100 million in assets and offers investors a way to benefit from the boom without taking on single stock risk that can come with failed IPOs such as inflight Internet service provider Gogo ( GOGO), down 29% in just six weeks of trading.

The methodology behind FPX is easy to understand. It owns the largest 100 IPOs trading in the after-market. A stock is eligible for inclusion on day seven of its trading history through its 1,000th trading day. This means that Facebook ( FB), which is the largest holding in the fund at 10%, can remain in the fund for several more years.

The current sector make up favors consumer discretionary at 26% of the fund followed by tech at 18%, energy 17% and health care at 16%. In FPX' lifetime the sector allocation has changed significantly. When the fund first began trading, the financial sector made up 32% of the fund due to large weightings in Genworth Financial ( GNW), Chicago Mercantile Exchange ( CME) and NYSE Euronext ( NYX). FPX has just 7.25% in financials now.

As mentioned, Facebook is the largest holding at 10%. The fund is market cap-weighted but modified to limit any stock to 10% of the fund. Drug company AbbVie ( ABBV), which was a spinoff from Abbot Laboratories ( ABT) last December, is the second largest holding at 9% followed by General Motors ( GM) at 7%.

Year to date, FPX is up 28% versus 20% for the S&P 500 and for the trailing 12 months FPX' outperformance increases as it was up 44% versus 20% for the S&P. Prospective investors in FPX should also look at the period from May 31, 2012, to Aug. 31, 2012. This was significant because it was the first 90 days that Facebook could be included in the fund. Facebook had notoriously poor performance dropping 52% in its first three months of trading.

Despite the poor performance from such a large holding FPX only lagged the S&P 500 slightly, going up by 5% during those three months versus a gain of 6.9% for the benchmark. That speaks well for the methodology of the fund.

One thing that FPX does not do is capture the first-day pop that comes with some IPOs. Noodles & Company's IPO was priced at $18 per share, opened for trading at $32 and closed that first day at $36.75. Although in this case it would have been better if NDLS could have been included in FPX from the start, the stock is still up 14% from its seventh day of trading, the day it was first eligible for inclusion, compared to a 4% gain for the S&P 500.

The IPO market can also be an indicator of what is going on in the broad market. The history of IPOs is they tend to be hot late in the stock market cycle. Most investors will remember the flurry of tech- and internet-based IPOs in the late 1990s. FPX has outperformed the market more often than not in its seven-year history but 12-month periods where it outperformed by 20%, as it has in the last 12 months, are rare including the 12-month period ending July 2007, which, of course, was three months before the 2007 peak.

This type of indicator can never be taken as a certainty but can be looked at as a warning for when the next bear market might start.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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