While several providers were mentioned in this article, the author is not related to any of these providers, nor paid by any of these providers in any form for their mentions or direct links.
An IPO can potentially provide an investor the opportunity to obtain new shares of a company before they are listed and traded on the stock exchange. Sometimes, an investor can take advantage of quick profits if the price rises when the securities initially start trading in the open market. For hotly contested IPOs of famous companies, there is a general, whether justified or not, expectation that the prices are likely to rise post IPO.
1. Read the prospectus
The IPO prospectus is often a comprehensive document detailing the business, the offering and allocation of raised fund. However, it is paramount to note that this is document is a very much piece of “self-serving testimony”. While not all biased documents are untrue, it is important to test the information provided in the prospectus with your own research.
2. DYOR (Do Your Own Research)
Aside the usual course of Googling and browsing social media sites, a fundamental pitfall to avoid when doing self-research is to avoid confirmation bias.
Confirmation bias is a conscious or sub-conscious effort to look for information confirming your pre-existing position. Here, if you already think about participating in an IPO, you may be tempted to look for only information that confirm your view that the IPO will be a success.
Self-research should rather be about reverse confirmation bias—build an argument as if you believe the IPO will be a flop, a failure—and see if the evidence you found managed to convince you otherwise or not.
3. Hype trains do de-rail and do so more often than you think
Hotly contested IPO is not, by any means, a guarantee to make money if you get in the action. Just because a company is famous, reputable, and believed by the world to have a successful IPO, it does not necessarily mean the share price will not dramatically fall, at least in the short term. A most recent household name IPO that flopped was Uber.
Another key point would be that hype, even if completely justified, does not last forever. some Individuals and institutions are always looking to take-profit during the peak of the hype.
Three ways to invest in an IPO
There are several ways to get into the IPO action. However, each method offers its pros and cons. As an investor, you will need to weight your options carefully in terms of which option suits your personal circumstances the best and it is always wise to talk to a financial advisor.
1. Through an IPO ETF
An IPO ETF is an exchange traded fund where the fund invests in companies that have gone public in the last x number of years. The duration and specific investment in terms of geography differs depending on the specific fund.
One distinct advantage of such a product, like all ETFs, is that it saves you the time and effort to do the research yourself, but reliant on a qualified fund manager to make that decision on behalf of the fund. A second principal advantage would be diversification can be achieved to significantly lower the risks of participating in IPO issues. Of course, this will also mean you get to participate in many IPOs rather than just one. The minimum investment requirement is usually low, as all ETFs.
The downside can also be significant. One such downside is that aside from not being able to choose which specific IPO you may want to participate in, the duration of investment may also be somewhat uncomfortable (usually a few years), if you wish to sell one specific IPO shares immediately after or shortly after the listing, this product may not be for you.
Exchange traded fund can be purchased from several brokers in New Zealand and abroad. Sharesies (https://www.sharesies.nz
) and Hatch (https://www.hatchinvest.nz/
)in New Zealand being the two most prominent examples with similar offerings.
2. Through a broker of IPO shares
Direct participation would usually require you to sign up with a broker. The broker bid on your behalf with a lead broker, in hope of allocations.
ASB Securities (related to ASB Bank), provides an excellent summary how this works in the link below, and is a prominent local access broker for this service.
This method is almost the opposite of option one outlined above. However, one key disadvantage of this method is that allocation is not guaranteed. For hot IPOs, or IPOs that attract enormous international attention, average allocation can be very low, or missed opportunities.
3. As a cornerstone investor.
Simply put, cornerstone investors are investors who subscribe for shares (or units, in the case of real estate investment trusts—REITs—or business trusts) in an IPO or follow-on equity offering, and who benefit from an allocation of stock that is pre-agreed in advance, both with the lead banks (that is, the global coordinators and bookrunners) and the issuer.
Investing as a cornerstone investor means guaranteed allocation, which can be an extremely attractive proposition in a hotly contested IPO. However, cornerstone investors need to have sufficient size to be wholesale investors.
In addition, cornerstone investors are near always subjected to lockup period, usually for six to twelve months. This means, immediately upon listing, the shares cannot be sold or traded until lock-up period expires. The additional risk is that, during this period, the IPO flops and price nose dives, which results in significant losses than otherwise being able to offload and mitigate these losses immediately post-listing.
Whether the guaranteed allocation is worth the additional risks, is a key question worthy of great consideration before investing as a cornerstone investor.