For the past two-and-a-half years, the Renaissance Plus IPO Aftermarket Fund (Nasdaq:IPOSX) has been the only U.S. fund to invest most of its assets in new issues. But that is about to change with the recent registration of the Hambrecht & Quist IPO & Emerging Company Fund.
The San Francisco-based newcomer will offer the public shares in a $300 million closed-end fund. The fund will invest 65 percent of its assets in new issues and 35 percent in other instruments.
Here's how it works: IPO shares are bought from a syndicate whenever possible as a company goes public, or else during the first 18 months of a company's public debut. The fund sells the shares it purchased within one year.
Hot Sector
IPO funds allow individual investors to gain entry into a hot sector to which they have little or no access. At the same time, some investors may eye them for the safety usually associated with mutual-fund investing.
Fund watchers caution, however, that historically IPOs have been a volatile investment. They do not think many more IPO funds will enter the market.
"Most studies have shown that IPO [funds] overall don't do very well," said Russ Kinnel, a senior mutual fund analyst at Chicago-based Morningstar.com. "They tend to have huge rallies and huge declines even more than typical small-cap growth funds. That's because the IPO market is so volatile."
Hambrecht & Quist plans to use a quantitative model developed by Symphony Asset Management, the company that will manage the fund. The model will help decide which issues to buy and to sell and when. Because Hambrecht & Quist is also an underwriter, Symphony would have to buy from other investment banks on occasions to avoid a conflict of interest.
Greenwich, Conn.-based Renaissance, by contrast, does not use a mathematical model but bases its selection process on in-depth analysis, says William Smith, the company's president and one of the three fund managers.
"Our mandate is to look at and analyze every single IPO that's out there, go to the road shows, and talk to competitors and suppliers," Smith said.
In addition to scrutinizing every stock, the fund managers research each sector before making a decision.
"Not only are we ranking and comparing the two closest comparable stocks, we ask if we should even be in retail right now," he added.
As of July 31, the fund had a year-to-date return of 31.02 percent. In 1998, the fund's first full year, it reported an 18.4 percent gain despite the August hit that dampened the rest of the market. Some of the fund's holdings include shares in E*Trade, Equant, Amazon.com and School Specialty.
The fund is allowed to hold the stock from an IPO for up to five years after the offering.
"We are not flippers," Smith said, adding that sometimes, when a stock falls and momentum players sell, Renaissance may decide to buy. "If you have done your homework and know this is an exceptional company, that's the time to start buying again," Smith said.
Pure Play
While Renaissance is the only IPO pure-play, numerous growth funds invest 10 percent to 40 percent of their portfolios in new issues to help boost their returns. They include the Munder Net and the Oppenheimer Enterprise funds.
But IPOs also add volatility, which can create problems when the fund does not disclose that fact.
Last month, the Securities and Exchange Commission censured and fined the Van Kampen Investment Advisory Group $100,000 for failing to disclose that about 50 percent of the meteoric gains of an "incubator" growth fund came from "hot" IPOs. These are new issues that the SEC defines as those that trade at a premium.
Between 1996 and 1997, when the fund only had $200,000 to $350,000 in assets, IPOs propelled returns to 69.9 percent. The returns were advertised without mentioning the IPO effect. When the fund opened to the public in 1997 and assets grew to $109 million, the impact of IPOs was diluted, and returns took a hit.
The SEC does not have any particular disclosure requirements for IPOs. Rather, its focus is on informing investors of any potential risks, says Amy Gibson, an attorney with the SEC.
"There is no attribution requirement, but what you do have to disclose are things that have a material impact," Gibson said. The Van Kampen Enterprise Fund, for example, has $3 billion under management and also invested in IPOs. "But because of the size, IPOs did not have the same impact," Gibson said.
Using IPOs to boost returns is common practice among mutual funds. The question is to what degree. Usually, a family of funds divides the allocations among fund managers. If one manager wanted all the IPO shares "he'd be barbecued," Smith says, adding that the scarcity of IPO shares is one of the reasons there are so few IPO funds.
Renaissance has only $16 million under management, 1,400 shareholders and a universe of about 30 stocks. It is an open-end fund, which means it is free to increase its size.
Some funds take a hit from IPO exposure. Smith Barney's Special Equities Fund invested heavily from 1994 in Snapple, Boston Chicken and other stocks that initially posted huge gains, which were later wiped out. After temporary gains, the Smith Barney fund suffered heavy losses and was "merged out of existence," Kinnel says.
Currently in registration, another fund, LCM Internet Growth Fund, is planning to invest about 65 percent of its assets in companies that engage in the Internet or Internet-related activities. Led by LaSalle Securities, the company is offering 4 million shares at $10 each in an open-end fund.
As such, it may invest some of its assets in IPOs, as many Internet companies are so new they are still in the first year of existence and qualify as a new issue.
Renaissance has done well, Kinnel acknowledges, but says it's premature to comment on Hambrecht & Quist's prospects, or on Renaissance's future.
"The more volatile the investments, the longer the period you need to assess the fund," Kinnel said. "Come back in five years and see."
Avital Louria Hahn is a senior editor of The IPO Reporter, a sister publication of Traders Magazine.
