How to invest like the top 1% of the 1%

If you've ever wanted to dabble in IPOs like the biggest players do, here's your opportunity. There's some risk, though.

By StreetAuthority May 1, 2014 11:44AM
Businessman with cigar © Juice Images , SuperStock By David Goodboy

Paradoxically, the trying economic conditions over the past several years have been perfect for super-rich and connected investors -- the top 1 percent of the 1 percent -- to exponentially increase their wealth.

One of the more popular but seldom talked-about tactics is known as IPO flipping. This refers to the practice of buying IPO shares at the initial offered price then quickly reselling them once the shares start trading -- and profiting from the initial pop.

However, only institutions, hedge funds and very wealthy investors are allocated shares by the underwriting broker before the IPO. Even though most regular investors are precluded from IPO flipping, they can still learn a profitable lesson -- never purchase an IPO on the first day of trading.

Sure, it's tempting to buy a newly issued stock as prices rocket higher that first day -- but share prices often retreat just as quickly. This is because the flippers are dumping their often substantial allocations as the public is trying to scoop up shares.

Last year saw the most IPOs since the height of the dot-com bubble in 2000, and the surge in IPOs is showing no signs of abating this year. As of February, IPO filings and proceeds were far outstripping 2013 numbers, with a greater average first-day gain.
However, it's important to note that the average market cap of IPOs this year has dipped dramatically during the first 60 days.

Because most investors aren't allocated IPO shares to flip, the best and least risky way to get a piece of the IPO pie is with an IPO ETF (exchange-traded fund). The most popular such ETF is the pioneering First Trust IPOX-100 (FPX). Launched in 2006, this ETF tracks the U.S. IPO market as reflected in the IPOX-100 Index.

What's most appealing about this ETF is that it has built-in risk-reducing measures. It doesn't invest in every IPO: Its risk-reduction rules exclude REITs (real estate investment trusts), closed-end funds, and ADRs (American depositary receipts) of foreign firms. Companies must have a market cap of at least $50 million, and each company's IPO must offer at least 15 percent of its outstanding shares.

Most interestingly, the index excludes any company that skyrockets over 50 percent on its first day and doesn't invest until the firm has been public for seven days. This strategy cuts into the potential profits from superstar IPOs that rocket out of the gate and keep on going higher, but its risk-mitigation benefits outweigh the rewards of catching a few high-fliers.

Finally, companies are removed from the index on their 1,000th trading day. This keeps FPX true to its roots of being an IPO fund but may limit its upside.

Part of the First Trust fund family, FPX is considered to be in the large-growth category, with close to $510 million of net assets and has an annual expense ratio of 0.60 percent. Over the past five years, FPX has returned an average of 23.2 percent a year, including 31.1 percent last year.

Facebook (FB) is the top holding at just over 9 percent. Tesla (TSLA), Kraft Foods (KRFT) and Hilton (HLT) are also among FPX's top 10 holdings. Consumer cyclical stocks have the greatest sector weighting at 27.3 percent, followed by tech stocks at 18.9 percent, energy at 15.4 percent and health care at 15.2 percent.

Technically, shares have been trending down since topping $48.50 in early March. There is technical support at $43.50, and FPX is still solidly above its 200-day simple moving average near $43.
Risks to consider: Investing in IPOs is very risky. Not every IPO is profitable, and sometimes they crash upon issue. FPX mitigates some of this risk, but some risk still remains. Always use stop-loss orders and diversify when investing.

Action to take:
I like buying FPX on this pullback. Buying in the $45.50 to $44.50 range with stops just below the 200-day moving average at $42.50 makes solid investing sense right now. I would then the 200-day moving average as a line in the sand to re-enter positions when violated on the upside. My 12-month target for this ETF is $50.

David Goodboy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

More from StreetAuthority

May 1, 2014 12:41PM
when only the well-connected can buy shares pre-ipo. the system is rigged. and they rub it in your face
May 1, 2014 1:19PM

If you look at the raw statistics, the rich don't usually invest in IPOs. The rich generally invest in real estate, hedge funds, or venture capital opportunities. Another interesting statistic is that they generally don't make any better of a return on their money than someone investing in low fee index funds or small real estate properties. The rich really aren't any smarter than the rest of us and are generally just as gullible. One example, Madoff took thousands of them to the cleaners.

May 1, 2014 1:40PM

i wouldnt say the well-connected.. if you have enough money you can buy ipo in anything.

whether it does well is anyones guess.

the really successfully either have old money or are smart investors like buffett.

giving you money doesn't make you smart.

you can lose a billion as easy as you can lose 10 thousand.


May 1, 2014 12:56PM
May 1, 2014 4:06PM

Usually the well connected(investors) and bankers are the ones carrying and selling the Game...

Yeah, they normally make out pretty good, along with the founders.

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