“How do I buy the Alibaba IPO?”
That’s the refrain du jour with China’s largest and most intriguing e-commerce play expected to make its initial public offering Sept. 19.
We are talking about a company that could go public at around $160 billion and raise some $15 billion, putting it among some of the biggest tech deals in history, after all. So the buzz around the Alibaba IPO is understandable.
But the privilege of “getting in early” and profiting off a potential first-day pop rests with the big money — those Alibaba is courting in its 10-day roadshow — leaving you and me out in the cold. That reality has sparked a search for sneaky alternative ways of buying the Alibaba IPO; for instance, buying or trading options on Yahoo (YHOO), which owns 22.4% of Alibaba and will see a huge windfall from the offering.
The one I want to talk about, though, is the seemingly sensible-sounding suggestion that investors buy the Renaissance IPO ETF (IPO).
The theory is simple enough. The Renaissance IPO ETF holds a bundle of recent initial public offerings that list in the U.S., and a marquee name like Alibaba is sure to be among IPO’s holdings.
But does it stand up in practice?
Why You Should (And Shouldn’t) Buy the Renaissance IPO ETF
First off, you’re never going to catch any first-day pop. It’s right there on Renaissance’s IPO page:
“New companies are added to the Renaissance IPO ETF on a fast entry basis on the fifth day of trading, or upon quarterly review, and are removed after two years when the IPOs become seasoned stocks.”
In short, the IPO ETF can’t buy shares ahead of the offering, so any of those explosive first-day gains will be long gone by the time BABA stock lands in IPO’s portfolio. That’s an even bigger strike against it when you consider that the fund could be buying Alibaba at an extremely frothy high.
But that’s not always how all IPOs play out, so Renaissance won’t necessarily get bit on the butt by being behind every IPO. Take recent big-name addition Mobileye (MBLY) — the IPO ETF missed out on MBLY’s 50% first-day burst, but the stock has climbed another 57% since it was eligible for inclusion in early August.
There’s also the matter of fees. Granted, you won’t miss 0.6% in annual expenses if Alibaba shoots over the moon and lifts the IPO ETF with it, but it’s an added expense you wouldn’t have if you just went out and bought BABA outright.
Really, the decision about whether you want to buy the IPO ETF comes down to two questions:
“Why does one buy an ETF?” and “Why does one buy an IPO?”
To answer the first: Typically, if you’re buying an equity ETF, you’re either seeking out easy diversification, and/or you’re seeking to invest in a theme. The Renaissance IPO ETF actually fits both bills — it invests in companies that should be in the growth stage of their life cycle, and it allows you to hold some 70 of these companies, so if one or two bomb, you’re not out your full investment.
To answer the second: The primary reason investors buy into IPOs is growth — the potential for doublers and triplers as a company comes into its own. But if that’s the case … why would you buy 60 or 70 other companies to get the one you want, especially when you’re not gaining any exclusive, early access to that stock for the trouble?
Granted, BABA stock should take up considerable space within the IPO ETF. The fund weights companies by float-capitalization value (a measure having to do with the actual number of shares that are publicly owned), so Alibaba should enjoy well more than the 11% weighting currently given to top holding Twitter (TWTR).
Still, if you’re full bull on Alibaba, why would you take 10%, 15% or 20% exposure to what you expect to be breakneck growth when you could be fully invested?
There is one notable exception to this logic, and that’s biotechnology companies. Biotech ETFs such as the SPDR S&P Biotech ETF (XBI) and iShares Nasdaq Biotechnology ETF (IBB) essentially do the same thing — they allow you to reap some of the benefits of high-growth medical technologies without all of the risk. But biotechs are virtual gambles, with stocks living and dying by clinical trials in a space where the vast majority of products never come to market.
Alibaba isn’t a sure thing (no stock is), but it won’t die overnight, and one can make a reasonable business analysis of BABA without having to handicap the chances of an FDA board saying “yea” or “nay.”
Bottom Line
The Renaissance IPO ETF isn’t even a year old, and in that time it has trumped the S&P 500 by just 1 percentage point, so it’s difficult to tell whether IPO’s formula is one you can depend on long-term to produce market-beating returns. Still, the idea of targeting up-and-coming companies is a sound one. Over time, IPO really might prove itself worthy of investment.
But, if you are excited about the Alibaba IPO, and you believe in the future prospects of the Chinese e-commerce giant and want to buy BABA stock, don’t hedge your bets … just buy shares once they become available to us plebs.
Kyle Woodley is the Deputy Managing Editor of InvestorPlace.com. As of this writing, he was long IBB. Follow him on Twitter at @KyleWoodley.
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