First Trust IPOX 100 Index Fund, What is it good for?

Greg Newton has has written a good article "ETF du Jour: IPOX-100 sets sail" about the new First Trust IPOX 100 Index Fund. I basicly agree with him that the investment case for investing in initial public offerings as a class has not been made. Not by First Trust, and neither by index provider IPOX Schuster LLC

IPOX Schuster is almost as bad as powershares in not documenting index methodology.One of the many advantages of ETF's over classic mutual funds is that the portfolio is open and deterministic. IPOX Schuster makes only vague comments about the exclusion criteria for the IPOX index.Without any filtering for the quality of the IPO companies, FPX could become cluttered with various dot-bombs and overleveraged zombies tossed out by private equity companies. IPOX Schuster does claim that Sabarnes-Oxley has improved the quality of IPO companies, but I disagree. You still see a fair amount of immature uninvestable companies (now with good accounting) being offered for sale. The reference to “pre-IPO accruals management and long-run stock price performance” refers to IPO’s of companies with low quality earnings and precious little internally financed growth tend to tank. And recent IPO’s like (CROX) are a perfect example of the problem.

One of the big problems with the current IPOX fund is that it has %10 weight cap and (GOOG) is 10% of the index. I wouldn’t want to have a single penny invested in that bubble. Since Russell has a policy of including IPO’s in their indexes on a quarterly basis, the Russell indexes will capture any IPO outperformance effect. I believe that Wilshire 5000 and other total market indexes also includes IPO’s quarterly.

After GOOG leaves the index I could see FPX as being part of a very long term passive portfolio, where FPX is intended to capture new growth during growth phases of the economy. Another use of FPX could be to balance a pure large-cap blue chip portfolio with younger fresher companies A similar solution would be to invest in the Russell Microcap and Russell 2000 Indexes which would give you full exposure to the small/micro company sector (Companies -1000 to 2000 in the Russell market universe) where most IPO’s start.