ETF Looks to Capitalize on Hot IPO Markets

NEW YORK (TheStreet) -- Earlier this year I wrote about how well the First Trust US IPO Index Fund (FPX) was doing. Indeed, it is up 33% so far in 2013. After having the domestic IPO ETF market to itself for more than seven years FPX will now have competition from the new Renaissance IPO ETF (IPO), the company with an iconic ticker.

Renaissance Capital has long been a leader in IPO research, maintains several indexes of IPOs and also runs the IPO Plus Aftermarket Fund ( IPOSX) which is an actively managed product versus IPO which will be an indexed product.

The biggest difference in the methodology between FPX and IPO is that FPX allows constituents to remain in the fund up to the first 1000 days of trading but IPO limits inclusion up to just 500 days. A stock is eligible for inclusion in IPO on its fifth day of regular way trading.

By waiting until the fifth day of trading the fund will obviously miss out on any first day pop in the price but IPOX, the firm behind FPX, believes that waiting before including a stock into its indexes helps reduce volatility of the fund.

At the sector level IPO is heaviest in technology at 24% of the fund followed by 18% in financials, 16% in consumer services, 15% in consumer goods and 12% healthcare.

The largest holdings in the fund are Facebook ( FB), Delphi Automotive ( DLPH), Zoetis ( ZTS) and Michael Kors Holdings ( KORS) all with approximate 10% weightings which is the limit any one stock can have in the fund. Without modifying the market cap weighting Facebook would have more than a 30% weighting in the fund.

For some other details; the fund has 49 holdings, charges a 0.60% expense ratio and has 63% of its holdings in large cap stocks which is logical for a market cap weighted product.

In an interview on CNBC, Renaissance Capital Principal and IPO fund manager Kathleen Smith talked about her firm's unique idea that because new companies are typically not included in the major indexes for about two years which is about how long, 500 days, IPO holds It constituents for. By omitting IPOs for that initial period, Smith said, traditional index investing is incomplete. IPO is being put forth as a way to round out complete exposure to the US market.

A last point made by Smith is that despite how well IPOs have done this year, 2013 is nothing like the late 1990s when there were more than 500 IPOs in some years and she believes the current IPO boom has a long way to go.

Smith is making an important point. A major contributing factor to the tech wreck in 2000 was that the market was flooded with a new supply of stocks, the IPOs, that eventually overwhelmed demand and so prices fell.

While there is obviously the potential for self-serving comments from the manager of any niche product it is true that there are fewer IPOs these days; in 2013 there have only been 130 new offerings and there is reasonable sector diversity with today's new issues compared to the late 1990s.

The argument made by Smith for a more complete domestic exposure is less compelling than the stellar track record put in by first to market FPX since its inception. The only year that FPX lagged the S&P 500 was 2008. There can be no certainty for continued outperformance but seven years is a reasonable sample size to argue that owning a basket of IPOs is a valid strategy and if FPX can continue to succeed then it is also likely that IPO would also succeed.

At the time of publication the author held no positions in any of the stocks mentioned.

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

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