IPO as a Growth Mode for an Exchange Traded Fund

Initial Public Offering as the Lifeblood of FPX and CSD

A Market Brief
by

Steven Ki

MintKit Investing
www.mintkit.com

Disclaimer This brief is provided as a resource for information and education. The contents reflect personal views and should not be construed as recommendations to any investor in particular. Each investor has to conduct due diligence and design an agenda tailored to individual circumstances.

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%hort %ummary
A nifty way to e&cel in the stock market is to draw on the initial public offering 'I()* as the cru& of an exchange traded fund 'ET+*. In this way, the peppy performance of an I() can complement the efficiency and longevity of an inde& fund. A pioneer in this domain lies in a tracking vehicle called +irst Trust -% I() Inde& +und, which trades under the ticker symbol of FPX. Another spearhead is the .uggenheim %pin/)ff +und, which goes by the handle of CSD. To place the performance of the pacers in conte&t, the inde& funds were compared against a couple of renowned benchmarks of the stock market. As a backdrop, the %tandard 0 (oor1s inde& of 2"" giants serves as the leading pro&y for the bourse as a whole. Meanwhile the %0( 3"" Midcap Inde& is arguably the standard bearer for midsi4e stocks. The latter two benchmarks have spawned inde& funds of their own, in the form of SP! and MD! respectively. )n the upside, each of the vehicles based on fledgling stocks 5 namely, +(6 and 7%8 5 trounced the usual benchmarks of the stock market by a si4able margin. 8uring the window of evaluation stretching from !""9 to !"#$, 7%8 beat M8: by a comfortable margin despite a modicum of turbulence along the way; moreover, the overall gain for the go/getter was more than twice the payoff of $<= for %(:. The story was similar for +(6 only better. )n a negative note, the latter fund was a tad more volatile than %(: as well as M8:; on the upside, though, the cumulative gain for +(6 over the entire stretch was about !>= higher than the plump bounty bagged by 7%8. ? ? ?

E&tended %ummary
The vitality of an initial public offering 'I()* is a compelling approach to growth for an exchange traded fund 'ET+*. As a rule, a newborn listing in the stock market has a way of outpacing the market averages, especially during the first year of its debut on the bourse. In the combined approach, the robustness and longevity of an ET+ can be fortified by the vigor and potential of an I(). In the popular image, an I() refers to the sale of e@uity to the general public upon the initial launch of a bantam venture on a stock e&change. In the financial community, however, the terminology is also used to denote any type of fresh listing on the bourse. An e&ample of the latter is a stricken firm whose e@uity was delisted in the throes of bankruptcy proceedings. If an overhaul of the struggling firm turns out to be successful, then the return of the outfit to the e@uity market is regarded as the I() of a reborn stock. +rom a different angle, an e&change traded fund is a handy way to participate in diverse markets ranging from e@uities and bonds to commodities and currencies. In terms of scope, an ET+ may cover a broad swath such as a whole industry or even the entire economy. An e&ample of the latter is an inde& fund based on the flagship benchmark of the stock market; namely, the %tandard 0 (oor1s inde& of 2"" giants on the bourse. +rom the converse stance, a communal pool could focus on a compact niche. E&amples in this vein range from computer hardware and real estate to precious metals and foreign currencies. Ahatever the choice of market, though, an initial public offering can perk up the return on a portfolio. %ince the autumn of the !"th century, a raft of studies have shown that an I() is apt to outpace the bourse as a whole during the couple of years of its debut. )n the downside, though, the basic e@uities of operating companies are in general inapt as the primary vehicles for investment by the mass of participants in the stock market. The

reason lies in the endless hail of sideswipes and smashups in every industry ranging from mining and shipping to software and banking. The bugbear stems from a fact of life which is ignored by the simplistic models of orthodo& finance. In the real world, companies of all stripes break down and go bust all of a sudden, or fade out and die off in slow motion. By contrast, an inde& fund is much more likely to lead a long and productive life. The longevity of the vehicle springs from the continual process of renewal as the aging champs within the underlying inde& are replaced by rising stars in the marketplace. .iven this background, the best course of action for the mass of investors is to funnel most or all of their savings into communal pools based on market benchmarks. )n the downside, though, a market inde& is wont to track the established firms within its field of interest. +or this reason, the corresponding pool will contain little or nothing in the way of fledgling ventures. As we noted earlier, newborn stocks tend to outpace their older peers; and likewise outrun the bourse as a whole. In that case, the canny investor can ratchet up the return on investment by fleshing out a primary position in an ET+ in any domain with a secondary stake in one or more budding stocks within the same niche. An alternative ploy is invest in an inde& fund that consists entirely of new/sprung stocks. A pioneer on this front lies in a tracking vehicle called the +irst Trust -% I() Inde& +und; the ET+ trades under the ticker symbol of FPX. Another spearhead is found in the .uggenheim %pin/)ff +und, which goes by the call sign of CSD. To place the performance of the vanguards in conte&t, the inde& funds can be matched against a couple of renowned benchmarks of the stock market. In the larger scheme of things, the %tandard 0 (oor1s inde& of 2"" heavyweights stands out as the leading pro&y for the bourse as a whole. Meanwhile the %0( 3"" Midcap Inde& is arguably the standard bearer within the vale of midsi4e stocks. Each of the foregoing yardsticks has spawned an inde& fund of its own. The offsprings carry the ticker symbols of SP! and MD! respectively.

8uring a window of evaluation stretching from !""9 to !"#$, the inde& funds based on infant stocks 5 namely, +(6 and 7%8 5 beat the prime benchmarks of the stock market by a hefty margin. +or instance, 7%8 trumped M8: by a solid lead despite a modicum of turbulence along the way. Moreover, the overall gain for the live wire was more than twice the payoff of $<= for %(:. The story was similar for +(6 only better. )n a negative note, the dynamo was a tad more volatile than %(: as well as M8:. )n the upside, though, the cumulative gain for +(6 over the entire stretch was about !>= higher than the copious bounty bagged by 7%8. ? ? ? Ke words! I(), ET+, E&change Traded +unds, Inde&, Benchmark, .rowth, %tock, Market, Midcap, Investing, Cisk, Ceturn, %(:, M8:

? ? ? A dandy way to e&cel in the stock market is to draw on the initial public offering 'I()* as the essence of an exchange traded fund 'ET+*. In this way, the lively performance of an I() can complement the efficiency and longevity of an inde& fund. +or the vast maDority of investors, an e&change traded fund is the best vehicle for participating in sundry markets ranging from stocks and bonds to currencies and commodities. In some cases, an ET+ could cover a broad swatch of the marketplace. A showcase lies in an inde& fund whose mission is to mirror a leading benchmark of the stock market as a whole. In other cases, a communal pool could focus on a smaller niche. An e&ample involves an e&change traded fund dealing with real estate, precious metals, or medical tourism. Ahatever the choice of market, though, an initial public offering can serve as an adDunct to a primary position in an inde& fund 'MintKit 7ore, !"#$*. The gambit of coupling an I() with an e&change traded fund may be e&tended further. More precisely, an entire fund could be composed of I() stocks. As a backdrop, a host of studies over the decades have shown that an I() is likely to outpace the stock market as a whole during the first year or two of its rollout. The vigor of the debutant also shows up in smaller patches within the bourse, as in the case of capital e@uipment or consumer products. By contrast to popular wisdom, the atomic stocks of operating firms are unsuitable for the mass of investors. The e@uities are problematic regardless of the type of business, whether the underlying firm happens to traffic in mining or refining, banking or retailing. The bogey springs from a grim fact of life which is swept under the rug by the traditional models of financial economics. To wit, the lot of all companies is to grow old and conk out

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sooner or later. The upshot is to clobber the shareholders who end up holding the bags of worthless stocks. By contrast, a communal pool based on a market benchmark is much more likely to endure and even flourish for decades on end. +or this reason, the smart move for the bulk of investors is to shunt most or all of their savings into inde& funds. Aithin the latter category, the most versatile and convenient pools take the form of e&change traded funds. As we have seen, newborn stocks tend to outsine their older rivals within the same niche as well as the bourse at large. +or this reason, the adept investor can beef up the return on investment by funneling a goodly sum into an ET+ based on I()s.

Initial Public Offering

)n the whole, the investing public thinks of an I() as the launch of a bantam venture for the first time in the stock market. Admittedly, this image of the debut reflects the notion of an initial listing on the bourse. In practice, though, the terminology is also used in a broader sense. In the looser usage, an I() refers to a fresh listing of any kind. A case in point is a venerable firm that has grown under private ownership for several generations but is now stepping into the stock market for the first time. A second e&ample involves a sprawling enterprise that has decided to spin off part of its operations as a @uasi/autonomous division. The offshoot may then show up on the bourse as a full/fledged corporation in its own right. A third instance involves a mature company pounded by the rigors of competition in a harsh environment. -pon falling on hard times, the pulped firm heading for bankruptcy would be delisted from the stock market. After a sweeping makeover, however, the restructured firm might be accepted into the bourse once more. In that case, the return of the e@uity to the public stage is also viewed as an I().

+rom the standpoint of an inde& fund, a focus on the big fish in the stock market offers a couple of advantages. )ne drawcard of a largecap stock lies in the li@uidity of the market. As an e&ample, the steward of a tracking fund can buy large blocks of shares in short order without causing the price of the stock to leap as a result of the surge of demand. +rom a converse stance, any attempt to buy or sell a si4able stake in a smallish firm is likely to change the price for the worse. +or this reason, dealing with biggish stocks is a lot more convenient than fiddling with the small fry. A second factor lies in the relative robustness of a colossusF a hulking company is more likely than a midget firm to survive a stormy spell in the marketplace. An e&ample of the latter lies in a widespread slump in sales in the throes of a recession in the economy at large. By contrast, a bantam firm is apt to go bust within a few years whether the economy happens to be surging or shrinking. The precarious state of affairs shows up in the fact that the vast maDority of newborn businesses fall flat and die out within five years of their startup.

Index Funds Dri"en b IPO #toc$s

In line with earlier remarks, an ET+ and an I() are not mutually e&clusive modes of investment. In particular, an inde& fund could track a yardstick of newborn stocks at the outset; that is, the first couple of years of their accession to the bourse. The main draw of an ET+ lies in its robustness while the lure of an I() springs from its vitality especially during the first couple of years. %ince the autumn of the !"th century, a host of studies have shown that fledgling stocks during the first year or two of their debut tend to outpace the bourse as a whole. An e&ample lay in a survey of public offerings in Europe over the period from #>>9 to !"#". +or the sample under review, some of the sapling firms were backed by ventures capitalists while others were not.

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The cadre of companies supported by venture capital comprised $92 names. )n average, this cohort outpaced the benchmarks of the market by E.33= during the first !2" days of trading. The latter timespan happens to be roughly e@uivalent to a single year1s worth of activity in the stock market. By contrast, the larger troupe of companies which had no backing from venture capitalists did not fare as well. The firms coping on their own were apt to trail behind the coached outfits by a modest amount. 8espite the weaker showing, though, the laggers on average still managed to beat the market benchmarks by a few percent during the first year of their launch on the bourse 'Bessler and %eim, !"##*. In short, the good news is that both types of hatchlings 5 whether backed by venture capital or not 5 outran the benchmarks of the market. This study, along with numerous other surveys, confirmed the power of the I() as a vital force in the stock market.

%enchmar$s and Trac$ing Funds

The +irst Trust -% I() Inde& +und is a tracking vehicle operated by a service provider named +irst Trust (ortfolios 'www.ftportfolios.com*. The inde& fund trades in the -.%. stock market under the ticker symbol of FPX. The purpose of the communal pool is to replicate, before fees and e&penses, the price and yield of a benchmark called the IPOX"#$$ %&S& Inde'. At this Duncture, we ought to pause briefly to look over the underlying yardstick. The target inde& is compiled by an information provider named I()6 %chuster 'ipo&schuster.com*. The mission of the vendor is to design financial products relating to I()s and spin/offs listed on the bourses of the world. The main offering is a lineup of benchmarks, each of which is branded as an Inde' of Initial Public Offerings 'I()6*. )ne of the yardsticks is the I()6/#"" -.%. Inde&. The role of the latter is to gauge the performance of the top #"" companies in the -.%. amongst the stocks ranked by market capitali4ation within the I()6 .lobal 7omposite Inde&. To wit, the American benchmark covers #"" of the largest saplings in the -.%. amongst the entrants covered by the I()6
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.lobal 7omposite Inde&. As a rule, the chosen stocks tend to be the most li@uid as well as the best performing. The inde& is updated on a @uarterly basis. In computing the yardstick, the contribution due to any stock is capped at #"= of the overall weighting. As a result, the benchmark belongs to a type of market average known as a odified value"(eighted )rice inde'.

By this means, the purpose of the benchmark is to portray the average performance 5 more or less 5 of the largish I()s on the -.%. bourse during their first thousand days of trading. The Inde& covers diverse sectors of the economy, across the gamut from technology and industrials to healthcare and consumer cyclicals. At this stage in the evolution of the benchmark, the top #" stocks within the inde& constitute Dust over half the weighting for the yardstick as a whole. The largest holdings in the portfolio range from +acebook and .eneral Motors to Kraft +oods and Marathon (etroleum. To take a pragmatic stance, we now return to the inde& fund that serves as the tracking vehicle; namely, +(6& The communal pool boasts a turnover of roughly 23,""" shares a day. )ver the course of $ years ending in late !"#$, the vessel turned in a capital gain of !3.2>= a year on average. Meanwhile, another inde& fund focuses solely on spin/off companies listed in the stock market. The vehicle is fielded by a fund manager known as .uggenheim Investments 'guggenheiminvestments.com*. The goal of the pool is to track a benchmark called the Beacon S)in"off Inde'. The latter yardstick is maintained by Beacon Inde&es, a division of a service provider named Beacon Trust 'beacontrust.com*. )n occasion, an established firm decides to create a stand/alone company whose mission is to concentate on a specific niche. As a rule, the parent firm would not bother to spin off a business in this fashion unless the prospects for the offspring were better than average for the target market.
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The role of the %pin/)ff Inde& is to monitor the progress of offshoot firms whose outlook in terms of risk and return are superior to those of other bantam firms. In fi&ing up the roster of stocks, one constraint lies in a measure of industry diversification. In other words, the portfolio should embody a balanced approach that covers an assortment of sectors rather than focus only on a few patches. In general, the yardstick is revised on a semi/annual basis. )n the other hand, the adDustment may be delayed if there are not enough fresh spin/offs to populate the benchmark. The underlying inde& 5 and thus the tracking fund as well 5 covers an eclectic mi& of companies. The top ten holdings within the benchmark include a content provider named (hoeni& Gew Media, a coal miner dubbed %un7oke Energy, and a fast/food chain called +iesta Cestaurant .roup. The %pin/off fund, which sails under the banner of CSD, boasts a turnover of some ###,""" shares a day. )ver the span of $ years ending in autumn !"#$, the go/getter bagged a windfall of !<.><= a year on average. To get a better handle on the results, we need to place the performance figures within a larger conte&t. +or this purpose, a couple of benchmarks fill the billF one yardstick dealing with largish companies and the other with middling firms. The most popular inde& of the stock market amongst professionals 5 be they active practitioners or passive observers 5 is found in the %tandard 0 (oor1s inde& of 2"" titans. The tracking fund for the flagship inde& trades under the ticker symbol of SP!. According to a recent tally, %(: turned in an average return of #9.>2= per annum over the course of $ years ending in autumn !"#$. In terms of transaction volume, the inde& fund is prone to chalk up roughly #!9 million shares a day. Moving on, we come upon the vale of midcap stocks. In this domain, the standard bearer takes the form of the %0( 3"" Midcap Inde&.
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The tracking fund for the latter benchmark goes by the handle of MD!& As a ballpark figure, the turnover for the rig amounts to some !.3 million shares per day. )ver the span of $ years ending in late !"#$, the return on the ET+ came out to #9.#2= per annum. Another way to si4e up the contenders is to e&amine the behavior of the vehicles over time. +or this purpose, an invaluable aid lies in a graphic display of the price history over a suitable time frame.

&hart 'ction
In taking up a visual tool, a handy choice for the earnest investor is a concurrent plot of the price history. +or one thing, the graphic display provides a visceral view of the behavior of the assets. +or a second thing, the simultaneous plot serves to highlight the relative performance of the candidate rigs. The chart below, courtesy of M%G Money 'money.msn.com*, covers a time frame in e&cess of < years starting with the launch of the +(6 fund in April !""9. The blue curve on the display portrays the movement of +(6 over time. As we can see from the left side of the e&hibit, the communal pool bounced around by a moderate amount during the first couple of years of its debut. After this peppy stage, the dynamo plunged into the abyss during the second half of !""E, roughly in tandem with the financial crisis that flared up the same autumn. The inde& fund hit rock bottom the following spring then powered higher in spite of the inevitable setbacks on occasion. )ne notable takedown cropped up in the summer of !"#". Another downcast occurred the following year, ending with a trough in tune with the crash of the stock market at large in autumn !"##.

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Aside from a minor pullback the following spring, +(6 has scaled the heights ever since. According to the number shown in the upper right corner of the graphic, the powerhouse bagged a capital gain of #">.<E= over the entire stretch covered by the chart. By contrast, the purple line depicts the path of 7%8 since its rollout in 8ecember !""9. After reaching a peak the following spring, the inde& fund began to crumble during the second half of the year. The vessel suffered a severe breakdown during the financial crisis then hit rock bottom in early !""> like the rest of its brethren. The laggard staged a comeback over the ne&t couple of years but was unable to erase the si4able gap in performance compared to +(6. The resurgent fund ran out of steam in spring !"##, then crumpled for half a year. The upshot was a bottom in the autumn in concert with the crackup of the bourse at large. %ince then, the live wire has made a respectable recovery. According to the bo&ed figure near the northeast corner of the e&hibit above, the capital gain for 7%8 since its launch came out to E".2<=.

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)ne one hand, the %pin/)ff fund trailed comfortably behind the leader in the form of +6(. Even so, the runner/up turned in a good showing compared to a couple of prominent benchmarks of the market. As in the previous section that focused on a window of $ years, we can compare the pair of dynamos against a couple of fitting benchmarks over the longer timespan covered by the chart above. +or this purpose, the apt yardsticks take the form of %(: for the heavyweights of the stock market, along with M8: for the middleweights. In the foregoing image, the orange curve portrays the path of the largecap fund while the amber line traces the course of the midcap pool. +rom the left portion of the display, we see that the two benchmarks turned in a comparable performance over the first few years. After that stage, each of the vessels suffered a nasty blow during the financial flap of !""E and its aftermath. In the wake of the smashup, however, M8: fund began to pull ahead faster than %(: over the ne&t couple of years. )n the downside, the midcap fund tumbled more than its largecap rival during the blowup of the bourse in !"##, in line with the norm in the e@uity market. After the meltdown that autumn, M8: began to push ahead once more. In due course, the midcap fund snagged a gain of 9!.#3= over the entire stretch covered by the chart. By contrast, %(: managed to carve out a modest gain of $<.$>=. Ahile the performance was not rousing, it was nothing to Deer at, either. To sum up, 7%8 crumpled a lot more than the renowned benchmarks of %(: and M8: during the financial crisis of !""E. Even so, the go/getter made up for its lousy performance by powering ahead over the years to follow. )ver the entire stretch from !""9 to !"#$, 7%8 turned in a si4able gain beyond the respectable outcome for M8:. Moreover the capital gain for the dynamo was more than twice the payoff of $<= for %(:.

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The story was similar for +(6 e&cept better. )n the downside, the hustler crumpled a tad more than %(: as well as M8: during the tempest of !""E. )n the upside, though, the cumulate gain for +(6 over the entire stretch was about !>= greater than the hefty bounty claimed by 7%8.

Further Information
An inde& fund is a convenient way to pull off an e&ceptional feat in the financial arena. Cemarkably, a complete novice armed with a smidgen of street smarts can outshine the bulk of players 5 ranging from casual amateurs to gung/ho professionals 5 without breaking a sweat. This cheery fact is discussed in an article at titled How to Beat the Investment +undsF )utrun Most Mutual +unds and Hedge +unds while Earning a Bonus. The writie/up can be downloaded freely from the Iibrary at MintKit 7ore. The field of e&change traded funds has enDoyed a spree of e&plosive growth since the eve of the millennium. Amid the ferment and hoopla, however, the panoply of information on the new/fangled vehicles often turns out to be incorrect, inconsistent andJor misleading. The bugbear of faulty information on ET+s is e&plained in an article called 7ruddy Information on E&change Traded +unds. The tutorial also presents a battery of countermeasures for dealing with the stumpers and pitfalls in the field.

(eferences
Bessler, A., and %eim, M. KEuropean Lenture/backed I()sF An Empirical AnalysisM. !"##J$J<. httpFJJwww.evca.euJuploaded+ilesJGews#JGewsNItemsJ!"##/"$/ "<N(CNEL7ANL7NI()NEuropeN%tudyNBessler%eim.pdf 5 tapped !"#$J##J!9.

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MintKit 7ore. KBoosting an ET+ with an I() 5 How an Initial (ublic )ffering 7an +ortify an E&change Traded +undM. httpFJJwww.mintkit.comJboost/etf/with/ipo 5 tapped !"#$J##J!9. Morningstar. KET+ (erformanceM. httpFJJnews.morningstar.comJetfJIistsJET+Ceturns.html 5 tapped !"#$J##J!9.

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