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Bigger is not always better

When it comes to investing, many people prefer the safety of big companies rather than backing the small ones. Many of us think bigger is better. But when it comes to initial public offerings (IPO), the reverse may be true.

Recent research on new floats by OnMarket concludes that of more than 1000 IPOs that went through the ASX from 2005 to 2015, the returns from smaller IPOs were markedly better than those from the big ones.

How much better? In the year after listing, companies listing on the ASX raising less than $50 million returned an average of 9.9 per cent, against 5.8 per cent for companies offering more than $50 million. The overall average return from IPOs was 9.1 per cent because small offerings were much more numerous than big ones.

The sample of 1049 IPOs is big enough to satisfy any sceptic, and the fact the smaller players outperformed the bigger ones by just over 70 per cent is noteworthy.

Listing rules may knock out winners, SMSFs

If we consider companies raising less than $20 million, there is again a material outperformance of IPOs worth more than that amount. Yet, proposed ASX listing rules would put a blanket ban on many smaller companies listing.

In particular, the ASX wants to increase the minimum market capitalisation threshold for companies from $10 million to $20 million to meet the assets test, which would substantially diminish investment opportunities available to investors. This rule would limit, for example, many emerging high-growth technology or biotechnology companies from floating.

At the same time, the ASX’s proposed amendments could exacerbate the exclusion of SMSFs from the IPO capital-raising process.

The ASX has proposed reducing the minimum number of investors a company must have to list to 100 (for large companies) or 200 (for small companies). That would leave most IPOs going to big institutions rather than SMSFs, which have a $600 billion pool of capital ready to invest. The ASX is proposing to bring in these new rules on 19 December, in the last week of the year prior to the Christmas holidays. However, the ASX rules, if implemented, would be no gift for SMSFs.

Why do smaller IPOs outperform?

So why do the smaller floats outperform? It has to be a factor that the bigger offerings enjoy a much higher level of coverage than the small ones, since IPOs live or die by the amount of public interest they attract.

The photo of model Jennifer Hawkins gracing the front cover of the Myer Holdings prospectus back in October 2009 is possibly a clue to why those two outcomes differ so much: they skew investor behaviour.

Myer’s $4.10 issue price has never been reached – the stock fell more than 8 per cent on its first day of trade. It’s now bouncing around the $1.30 mark after dipping as low as 83 cents in September last year.

It may not be fair to single out one big ($2.2 billion) float flop as an indication of how the new issue market works, but it is worth noting big-name floats can disappoint. Think also Dick Smith. This can give IPOs in general a bad name and even the good ones get tarnished, causing investors to go on a capital strike. Market professionals now say the Myer debacle all but closed the IPO window for about three years until 2012.

Invest broadly and spread your risk

A worthwhile conclusion from this research is that rather than trying to pick winners in terms of new floats, it’s more logical to aim for a wider IPO investment spread and reduce your risk.

IPOs can be a lucrative investment. The OnMarket July IPO Report 2016 reveals the average return from the 43 companies that had listed on the ASX from 1 January to 31 July 2016 was 26.2 per cent, easily outpacing a return of 5 per cent from the S&P/ASX 200.

But investing in IPOs is not always easy. For a start, there’s the issue of whether SMSFs can actually get an allocation of stock. ASIC recently published a report on “Sell-side research and corporate advisory: Confidential information and conflicts”, which made it clear big clients of the investment banks handling floats get the lion’s share of the stock allocations. These big clients are typically institutional investors, not SMSFs.

ASIC noted institutions that pay the most commission often get the best allocation, as do clients that offer “a commitment to engage in after-market buying in the corporate issuer”.

The report makes no comment about where smaller investors rank. But the fact is many company prospectuses simply state: “No shares are being offered to the general public.” So it is still the case most IPOs in Australia are largely going to institutional investors.

OnMarket is working to address this imbalance by offering companies the opportunity to offer IPO stock to all investors, including SMSFs, through its OnMarket tool.

SMSFs can use the OnMarket app and portal to research and invest in a broad range of IPOs, without paying commission or brokerage, with several companies now offering their equity directly to the public through this digital platform, enabling all investors to easily buy into these high-growth investment opportunities.

Importantly, the OnMarket allocation algorithm ensures investors get treated equally and fairly whether they are a big institution or an SMSF. ASIC’s recent report may too help to open up the IPO market and allow all investors to enjoy strong IPO returns.

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