Fund review: For a bite of the IPO action

India’s IPO market has been throwing up many money-making opportunities lately. But for retail investors trying to get in on a piece of the action, bidding in IPOs is a frustrating exercise. But if you’re set on investing in IPOs, here’s a workaround through the mutual fund route.

Hit or miss

Successfully bidding in IPOs isn’t easy. First, there are the very peculiar allotment rules for Indian retail investors applying to IPOs. In India, IPO allotments for those applying in the retail category (below Rs 2 lakh) are decided by a draw of lots and not proportionate allotment. No matter how many shares you bid for in the retail quota of a heavily subscribed IPO, your chances of bagging allotment remain exactly the same, as they are decided by a lottery system. ‘Lucky’ allottees in popular IPOs get just one lot. Therefore, in fancied IPOs, retail investors face poor odds of bagging allotment and if they do bag it, get a trivial number of shares that make little difference to their wealth. 

In the recent Nykaa IPO, for instance, retail investors whether they applied for 12 shares (1 lot) or 168 shares (14 lots) stood the same chance of bagging allotment (about 13 in 100) and got exactly the same number of shares (1 lot or 12 shares) in the retail quota. If you try to beat these rules by jumping to the NII quota (non-institutional investor), you need to put in an irrationally sized application to get shares. In the Nykaa IPO, NII investors applying for upto 624 shares (about Rs 7 lakh worth of shares) were allotted only 12 shares each. To bag 100 shares in this offer with certainty, your IPO application size had to be over Rs 1 crore. (See basis of allotment) Taking on IPO funding at high interest rates to gamble on this lottery is not all that wise.

Performance

Two, even if Lady Luck is smiling upon you and you manage to get allotment, the IPO you bet on may turn out a lemon. Promoters taking their companies public invariably bunch up their IPOs in peak bull markets, demand astronomical valuations and play on sectoral flavours of the season – which adds up to a majority of IPOs turning out to be poor long-term wealth creators. Our earlier article taking stock of over 400 IPOs from 2000 to 2020 showed that 57% of them had delivered losses, while another 21% didn’t get to a double-digit return. 

Still, steering clear of all IPOs in a euphoric market can be a painful call to take. If many IPOs deliver blockbuster listing gains, your FOMO can be severe. More importantly, when much of the listed universe consists of boring ‘old economy’ businesses that are being disrupted by new and nimble tech-driven rivals who are grabbing consumer attention and wallets, not playing the IPO game can mean staying out of truly exciting businesses that make your portfolio future-ready.

Mutual funds, being institutions, can get around the allotment woes by getting reserved allotments in the pre-IPO anchor placements in IPOs or by bidding in their QIB quotas. The Edelweiss Recently Listed IPO Fund promises to leverage this for your benefit. Through this fund, you will be able to address a good part of the issues explained above.

An IPO mutual fund

Launched as a 3-year close-end fund (Edelweiss Maiden Opportunities Fund Series 1) in February 2018, the fund was recently converted into an open-end fund, as the Edelweiss Recently Listed IPO Fund.

This fund is designed to invest at least 80% of its portfolio in the 30-40 stock ideas that it selects from the 100 most recently listed IPOs in the market. It caps individual stock weights at 5% for ‘secular’ stocks and 3% for ‘cyclical’ stocks, though it isn’t clear how it makes this distinction. Sector weights in all cases are capped at 35%. 

The fund follows a quality/growth style of investing, filtering stocks for earnings growth, ROE/ROCE and industry potential before applying a valuation filter. It needs to be noted that apart from participating in the anchor and QIB portions of IPOs, this fund also buys into IPO stocks post listing.

The fund charges a steep TER of 2.37% on the regular plan and 1.08% on the direct plan and has an additional exit load of 2% for exit within 6 months.

Performance review of the IPO fund

In the limited period since its inception (just over 3 years), the Edelweiss Recently Listed IPO Fund has outperformed the Nifty50 and its own custom-made benchmark. 

On a point-to-point basis, it has managed a 22.7% CAGR since inception against 16.96% on the Nifty50 TRI and 14.44% on India Recent 100 IPO Index (this index includes the latest 100 IPOs in the market with m-cap above Rs 100 crore. IPO stocks are included into this index only 3 days after listing, thus excluding listing-day gains). Of course, the fund’s show has been significantly boosted by the 82.8% gain in the last one year. 

On a rolling return basis, against the broad-market Nifty 500 (given the fund’s multicap portfolio), the fund has delivered a good show. It has so far managed superior average returns (27% versus 17%) with better loss containment (minus 17% versus minus 33%) and fewer instances of losses, despite dabbling in volatile IPO stocks. 

A comparison with the BSE IPO Index which follows a slightly different methodology from the India Recent 100 IPO Index, however, hints at the fund’s conservative investing choices. The BSE IPO index includes the stocks listed on the exchanges in the last one-year post listing, with stock weights capped at 20%. 

Against this index, Edelweiss’ Recently Listed IPO Fund doesn’t fare as well, with the BSE IPO Index managing much better average as well as maximum returns with a lower instance of losses. See the table below to get an idea of comparative performance.

Portfolio moves

A deep dive into the Edelweiss fund’s portfolio moves in the last one-year show that its muted show on maximum returns could be on account of its very selective participation in the much-hyped IPOs. The table below shows that of the five top performing IPOs of 2021 (Paras Defence, Nureca, Laxmi Organic, MTAR Tech, Barbeque Nation), the fund chose to skip four, bidding only in MTAR. Once it has stayed out of bidding in the IPO, the fund tends to (logically) refrain from participating in the stock post listing too, even if it continues to deliver stellar gains. 

It has, however, picked up IPO stocks with tepid listing performance from the secondary markets such as Aditya Birla AMC, Krsnaa Diagnostics, Vijaya Diagnostics and so on. This propensity to give many oversubscribed IPOs a miss (probably owing to valuation or business concerns) and buy into under-dogs has cost it in terms of ability to cash in on listing gains and post-listing performance. While one cannot fault the fund for staying away from some of these IPOs, this suggests that it may not be a suitable vehicle for investors looking to shoot out the lights with IPO listing gains.

Our take

Overall, the above analysis suggests that Edelweiss Recently Listed IPO Fund is a decent choice for investors looking to bypass allotment woes and add sound IPO firms to their long-term portfolio for fundamental reasons. Compared to you putting in big bids for IPOs and trusting to luck on allotments, buying this fund has some clear pluses.  

• Given that IPO stocks are susceptible to wild swings, the fund’s conservative stock weights at 3-5% help temper the risks associated with IPO investing. Investors also get to own a basket of professionally picked IPO stocks instead of trusting their stock selection to the allotment lottery. 
• The sector and m-cap allocations of the fund are well spread-out, with the latest portfolio featuring 30% in large-caps, 51% in mid-caps and 20% in small-caps. Though IPOs often tend to bunch up in sectors favoured by the market, this fund has taken care to maintain a diversified approach to sectors. The latest portfolio featured 15% in financials, 13% in services, 7% in construction and chemicals, 5% in consumer appliances and so on. An individual investor building a portfolio of IPOs may have trouble maintaining such stock or sectoral weights. (One tends to receive high allotments in less preferred IPOs and poor allotments in highly preferred ones!).   
• The fund has a very distinct portfolio from the existing menu of flexicap funds one might own. Statistics presented by the AMC show that while the top 10 flexicap funds in the market had a 4.8% to 15% allocation to newly listed stocks, this fund had 89% of its portfolio invested in such stocks. This gives investors opportunities to own stakes in new-age tech, consumer services and fintech stocks which may not feature as big weights in their existing flexicap funds.

  The fund has some clear negatives though. 

• If you are keen to participate in IPOs because of the possibility of doubling or tripling your money on listing, this fund is unlikely to fulfil that objective.  
• IPO activity in the Indian markets happens in fits and starts. IPOs usually bunch up and deliver big listing gains when bull markets peak and fizzle out the moment a correction strikes. Any fund that bets exclusively on IPOs is therefore likely to deliver its best show in peak bull markets, with returns slumping in bearish or sideways markets. Therefore, it is more an opportunistic addition to a portfolio than a long-term bet. 
• This also makes such funds better suited to lumpsum investments than SIPs.

The bottomline?

With several IPOs still in the pipeline, you may still be keen on participating in the IPO wave. But as bagging reasonable allotments is getting increasingly hard, using a fund route like the Edelweiss Recently Listed IPO Fund can get you a better shot at the IPO game. 

But given that market sentiment is a big factor in IPO performance, the fund should not be a core part of your portfolio, and nor should you view it as a long-term fund. It can be a booster to your existing portfolio of flexicap funds, to diversify your stock and sector choices, and you should have an exit strategy in place in terms of your holding period or target returns from it. 

Do also note that Edelweiss' Recently Listed IPO fund is not part of Prime Funds.