Should You Invest in IPOs Through Mutual Funds?

Do you want to invest in companies with high growth potential? Are you looking to build wealth over time? You could invest in an initial public offering or IPO to attain long term financial goals if it matches your risk profile. Private firms offer their shares to the public for the first time through an IPO. The privately-owned company becomes a publicly-traded company on listing its shares at the stock exchange. However, most IPOs are oversubscribed, and you may not get the IPO allotment. Should you invest in IPOs through mutual funds?

What are IPOs?

Companies issue their shares to the public for the first time through IPOs. It helps to understand that IPOs have different investor categories such as Qualified Institutional Buyers, Non-Institutional Investors and Retail Individual Investors. Moreover, the allocation of shares differs across these groups in an IPO. 

For instance, individual retail investors have a minimum allocation of 35% of the shares in an IPO. It helps to understand that individual retail investors apply for securities of value of up to Rs 2 lakh. Moreover, these investors are fast emerging as major players in the stock market. 

A company lists its shares on the stock exchange through the IPO and post-listing becomes a publicly-traded company. You can purchase and sell the company’s shares over the stock exchange. 

Should you invest in IPOs through equity funds?

Many people invest in IPOs for listing gains. For instance, the shares of a company launched through the IPO are listed on the stock exchange at the listing price. However, the listing price could be higher or lower than the IPO offer price.

You could make profits called listing gains if the listing price is higher than the offer price because of high demand for the shares. Many investors put money in IPOs only for listing gains and then exit the investment. However, financial experts recommend investing in the IPOs of well-managed companies and staying with the investment for the long run to maximise your returns. 

You can invest in equity funds that put most of their assets in IPOs if you cannot pick the appropriate IPO. These are thematic funds that focus on a unique investment theme: investing in firms that go public through IPOs. You do not have to concentrate on due diligence as the thematic fund picks the best IPOs and maximises return over time.

Many investors lose out on future gains as they exit their shares immediately after listing. However, thematic funds with high exposure to IPOs can maximise your returns as they hold the investment for a longer time post listing. Many newer businesses may enjoy earnings momentum, and mutual funds stick with them for a longer time. 

Many retail investors miss out on IPO allotment in good, financially strong companies because of oversubscription. IPO allotment happens through a computerised lottery where a few lucky investors get shares through the IPO. However, mutual funds can get IPO allotment through the IPO institutional quota or anchor book subscription. Moreover, mutual funds may buy shares even after listing at the right time and hold them for the long run to increase investor returns. 

What are the risks of investing in IPOs through mutual funds?

Thematic funds with high exposure to IPOs may invest in new-age businesses and tech-driven firms that have yet to earn profits. Moreover, these businesses are untested across economic and business cycles. 

Thematic funds may outperform other equity funds in the short run as IPOs can yield lucrative returns in a short time. However, you must not invest in these funds based on short term returns as they are riskier than many equity funds. 

You must invest in thematic funds with high exposure to IPOs only if it matches your risk tolerance. It helps if you treat IPOs as a long term investment rather than look for listing gains. In a nutshell, you could opt for the mutual fund route to invest in IPOs if you can’t choose the right IPO. 

For any clarifications/feedback on the topic, please contact the writer at cleyon.dsouza@cleartax.in