2 IPO ETFs Snatch Up Alibaba Stock. Here’s the One You Should Buy.

The Alibaba (BABA) stock offering was one of the most highly anticipated initial public offerings of all time. BABA stock was so popular among institutional investors that the two major IPO ETFs fast-tracked it for inclusion in their funds well ahead of their usual considerations.

alibaba stock ipo baba stockThe Renaissance IPO ETF (IPO) added Alibaba stock to its fund after five days of trading. Normally, the Renaissance IPO ETF doesn’t add recent IPOs until quarterly rebalancing on the third Fridays of March, June, September and December, but exceptions — such as BABA — are allowed where warranted.

The bigger First Trust US IPO Index Fund ETF (FPX) added Alibaba stock on Sept. 19, its first day of trading, because it happened to coincide with the date of its quarterly rebalancing. Normally, FPX only adds stocks that have traded for at least seven days.

IPO stocks can be extremely volatile in the first 12 to 24 months of trading. If you missed out on the first-day pop of Alibaba stock it might make more sense to buy either IPO or FPX instead.

Not sure which to buy? Read on, and I’ll tell you.

Alibaba Stock and FPX

The FPX is up 7.7% year-to-date through September 26. While in positive territory, the FPX ETF is underperforming the S&P 500 by 118 basis points in 2014. Despite this little bugaboo the FPX has had a spectacular run since its inception in April 2016. On only one occasion over the past seven years has the index outperformed FPX and that was in 2008 when almost everything did poorly. A second losing year isn’t going to sully its five-star reputation.

In case you’re unfamiliar with FPX, it replicates the performance of the IPO, which is composed of 100 of the largest and most liquid U.S. IPOs. Once bought, using Alibaba stock as an example, it’s held for 1000 trading days (approximately four years) and then sold. So, sometime in 2018 the managers of FPX will sell BABA and replace it with a recent IPO at that time, keeping turnover and trading costs to a minimum.

Investors interested in technology, consumer discretionary, health care or energy stocks should really like the FPX ETF because the four sectors account for 79% of the 100-stock portfolio. Other sectors such as financials and industrials round out the remaining holdings. Facebook (FB) and AbbVie (ABBV) are the top two holdings accounting for 20% of the fund with Alibaba stock in the top 10 at a weighting of 2.84%.

The FPX list of holdings is a cornucopia of names we’re all familiar. Using a semi-rigid buy-and-sell philosophy FPX removes much of the emotion that comes with IPOs. It might have bought Alibaba stock six days early, but it’s got another 993 days of trading to recover from buying on the first day.

Alibaba Stock and IPO

Renaissance Capital is very well known in financial circles providing institutions with research about IPOs since 1991. It’s had an IPO mutual fund — Global IPO Fund (IPOSX) — since December 1997 although it’s never really garnered much attention with just $11.2 million in total assets. The ETF came into being last October; at one-quarter the annual fee of IPOSX, it’s been able to capture $33 million in total assets in less than a year.

The big difference between IPO and FPX is that it holds stocks for just two years instead of four. In addition, IPO will fast-track stocks after five days of trading while FPX only considers an IPO after seven days and then only at the time of rebalancing. Renaissance’s big argument for two years as opposed to four is that it reckons these new stocks lose their sex appeal after a couple of years once moving on to major stock indexes like the S&P 500.

In terms of holdings, BABA is a much bigger part of IPO (10.1% weighting and largest holding) than in FPX. In fact, IPO’s and FPX’s top holdings are very dissimilar. For instance, IPO’s second-largest holding is Twitter (TWTR) at 10.0%; FPX doesn’t even give the social media darling 1%. IPO is a much more concentrated portfolio with just 73 stocks compared to 100 for FPX.

IPO invests 57% in mid-cap stocks  with just 24% in large-cap stocks. FPX flips that on its ears with 58% in large-cap stocks and just 34% in mid-cap stocks. If you’re a believer in mid-cap stocks, IPO is definitely more suited to your investment philosophy.

IPO ETF Bottom Line

With the exception of the last point about mid-cap stocks, of which I’m a big believer, IPO does not appeal. IPO’s older and more mature rival, FPX, is definitely deserving of all the positive press it’s gotten over the last few years.

I especially like the fact FPX has taken a smaller, more reasonable position in Alibaba stock, choosing not to overplay its hand. Given the questions that have arisen about FPX’s confusing structure, I see discretion as the better part of valor in this instance.

FPX is undoubtedly the better buy.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.

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