Initial public offerings (IPOs) are an exciting prospect. You’ve followed a budding business as it’s meandered a tricky path to floatation. Now, you stand with it as a frontier investor on the precipice of its public life. Or so it should be – there are problems investing in IPOs. Some perform badly. Deliveroo – or ‘Floperoo’ as it became known in the markets – dropped 26% in its first day of trading. And that’s if you can get hold of a share. For the most part, everyday investors are shut out of the process by the City. Here’s how to get involved.
Year starts strongly for IPOs
The initial public offering (IPO) – as name implies – is the first time a company’s shares trade on a public stock market. It comes with great fanfare for the company, and access to a deep pool of money, or capital. As investors, getting into a business early doors can be a crackingly lucrative endeavour.
This year has been the strongest start for IPOs since 2007, according to data from consultancy firm EY. With markets recovered from a Coronavirus-induced slump, 20 new listings on the London Stock Exchange have emerged in the first quarter alone. But, perhaps unsurprisingly, some share prices post-IPO have tanked. Floperoo is a case-in-point here.
While the merits of Deliveroo might have seemed sound, this flop highlights the difficulties wrought in valuing businesses sans public track records. Furthermore, as retail investors, you will not have access to senior management teams to drag them across the coals or question the validity of their business models.
Kyle Caldwell, Collectives Editor at Interactive Investor, remarks:
“An Initial Public Offering (IPO) can excite investors and even catch the attention of those who’ve never thought of putting money in the market before, if it is a company that they are familiar with. The risk, however, is that the IPO’s valuation is overhyped, which the market can take a dim view of once the shares make their debut.”
And this trickiness of valuation comes on top of issues with access – most retail investors cannot participate in IPOs. As a result, many investors can only dive in once shares start trading. It’s led numerous brokers including Hargreaves Lansdown, Interactive Investor, and AJ Bell to call for fairer access. Many agree. How can you not give retail investors the same advantages as professional ones?
Why investment trusts could be a good solution
The upcoming IPO rumour-mill is certainly at work. Whispers from the grapevine include brewer BrewDog and fintech darling Wise (formerly TransferWise).
Caldwell offers a solution for keen investor:
“Buying any share directly requires more work and effort than outsourcing the investment decision-making process to a fund manager or purchasing an index fund or exchange-traded fund (ETF).
“For investors tempted by IPOs but put off by the risk, one option is to consider investing indirectly via investment trusts in the Association of Investment Companies’ Growth Capital sector. Such trusts invest in unlisted companies, some of which will look to IPO when the time is right.
“This not only gives investors the opportunity to potentially benefit from the success of the company prior to listing, it also offers reduced risk as investors will be gaining exposure to a large number of potential new issues. Not all will perform well, but diversification is always a benefit for investors.”
Examples given include Chrysalis Investment Limited, a closed ended investment company which floated last September, which takes stakes in privately owned companies potentially headed for an IPO.