**1. Introduction**

Initial public offerings (IPOs) business has diachronically been of great interest to the investing community worldwide as investors deem IPOs as a great opportunity for significant short-term and possibly long-term gains. In addition, tens of tens of academic articles have been written on this field. The main finding of the literature is that IPOs are usually underpriced as depicted in their initial returns, which are significantly positive, either in absolute terms or when compared to corresponding non-IPO stocks or relevant market indices. Underpricing refers to the significantly low offer price of IPOs relative to the close price of stocks on their first trading day. On the contrary, when long-run returns are assessed, the academic research has shown that IPOs tend to underperform their reference portfolios.

This chapter focuses on IPO Exchange Traded Funds (IPO ETFs), which constitute an alternative vehicle for investors to enter the IPO business. An IPO ETF is an exchange traded fund that focuses on stocks of companies that have recently held an initial public offering. IPO ETFs are appealing to investors because they provide them with an inexpensive and flexible tool to invest in a large pool of initial public offerings. On the contrary, investing in such a large number of IPOs individually would not be practically feasible due to the high cost of such a strategy. In addition, IPO ETFs enable robust diversification strategies against the highly volatile IPO market. researchers in IPOs, our study should be highly welcome by the investing community and researchers. In addition, the positive initial returns and, even more importantly, the significant buy-and-hold returns revealed by our study should help investors plot profitable trading strategies. Finally, the results of the market trend performance analysis could also help investors implement strategies with mighty

*IPO ETFs: An Alternative Way to Enter the Initial Public Offering Business*

The remainder of this chapter is structured as follows. Next section provides a brief literature review on IPOs performance in the United States and other international markets. Section 3 develops the methodology used in our empirical investigation. Section 4 describes the data used in this study and provides information about the trading features of the sample's ETFs. The empirical findings of our research are presented in Section 5 and the conclusions are discussed in Section 6.

Given the lack of any research papers on IPO ETFs, we will provide a brief review of the main findings of the literature concerning the short- and long-run

A plethora of papers have examined the performance of IPOs using data from the United States. In early years, several studies, such as [1–7], have accentuated that IPOs are underpriced as can be inferred by the returns on their first trading days, which are significantly positive. In the same concept, [8] estimate that during 1990–1998, US IPOs left over \$27 billion of money on the table, where the money left on the table is defined as the price gain of the first trading day times the number of shares sold. The money left on the table is translated into significant underpricing of IPOs during the nineties. Furthermore, [9] report that in the 1980s, the average initial return on IPOs was 7%, whereas the average first-day IPO return doubled to almost 15% during the period 1990–1998, before jumping to 65% during the internet bubble years of 1999–2000. Finally, [10] shows that, after the bubble of 1999– 2000, the average initial return of IPOs in the US over the first decade of the new

The short-run performance of IPOs in other developed and emerging markets has attracted the interest of researchers. Loughran et al. [11] show that the move by most East Asian countries to reduce regulatory interference in the setting of offering prices resulted in less short-run underpricing in the 1990s than in the 1980s. Ritter [10] shows that in China, the second largest economy of the world,

underpricing of IPOs has been severe with initial returns amounting to up to 200%. However, over the recent years, IPO underpricing in China has started to decline as a result of the changing institutional constraints. The great underpricing of Chinese IPOs is also supported by the findings of [12, 13]. In Australia, Lee et al. [14] report strong first-day returns. Significant underpricing of IPOs is reported for Canada by [15] IPOs are underpriced in Japan too as evidenced by [16]. In the UK, Levis [17] has documented a significant underpricing of the companies going public in the British stock market. The same pattern has been revealed by [18] for Italy and [19] for France. More or less, IPO underpricing is a global phenomenon. To testify this assertion, Loughran et al. [20] report comprehensive statistical evidence of strong first-day IPO returns for a sample of 52 developed and emerging capital markets,

When it comes to the long-run performance of IPOs in the United States, the main conclusion of the literature is that that the stocks of companies going public tend to be overpriced in the long run. Overpricing is depicted in the underperformance of IPOs versus similar non-IPO stocks or relevant market indices. In this respect, Ibbotson

which range from 3.3% in Russia to 239.8% in Saudi Arabia.

potential of substantial gains.

*DOI: http://dx.doi.org/10.5772/intechopen.90269*

**2. Literature review**

performance of IPOs worldwide.

century was moving around 10%.

**99**

The origins of IPO ETFs go back to April 2006, when the First Trust US Equity Opportunities ETF was launched on the New York Stock Exchange (NYSE). The Renaissance IPO ETF came to the surface about 7 years later in October 2013. The Renaissance International IPO ETF followed 1 year later. The last entry in the IPO ETF market was the First Trust International IPO ETF. This fund began trading in November 2014.

In this chapter, we examine the short- and the long-term performance of IPO ETFs. In particular, we compute the absolute, benchmark-adjusted, and abnormal returns of ETFs. Abnormal returns are obtained with the usage of the market model successively against the S&P 500 Index and the S&P 600 Small Cap Index. These indices also serve as benchmarks when we calculate the benchmark-adjusted returns of ETFs. Moreover, in the short-run, returns are computed for the first trading day as well as for the first 2, 3, 4, 5, 21, and 63 trading days. At the long run, cumulative absolute, benchmark-adjusted, and abnormal returns are calculated over the first 6, 12, 18, and 24 months of trading and for the entire trading history of each ETF up to October 31, 2016. Respective buy-and-hold returns are computed too. Furthermore, risk-adjusted returns are estimated with the usage of a six-factor model, which follows the Fama and French multivariate model. Finally, a market trend analysis is performed. This analysis assesses the pricing behavior of IPO ETFs during the descending and the upward phases of the overall stock market.

The results show that IPO ETFs provide slightly positive average first-day returns given that the average initial return is positive but well below 1%. Going further, the average absolute return of IPO ETFs is positive over the first five trading days, but it is negative over the first 21 and 63 days of trading. Benchmark-adjusted returns are also positive up to 5 days when the S&P 500 Index is taken into consideration, but they are rather negative when the S&P 600 Small Cap Index is assessed. Finally, average abnormal returns are negative after the initial day of trading.

With respect to ETF long-term performance, results reveal positive cumulative absolute returns over the various periods considered, whereas the cumulative benchmark-adjusted and abnormal returns are positive only for the first 6 months of trading with the majority of returns becoming negative over the next time periods examined. In the case of buy-and-hold returns, results indicate that ETFs produce significant such returns in the long run, either when the absolute or the benchmark-adjusted returns are assessed. As far as risk-adjusted return is concerned, the regression analysis shows that just one out of the four IPO ETFs examined can produce robust and statistically significant excess return relative to market performance.

In the last step, the market trend analysis reveals that when the stock market goes down, the absolute return of IPO ETFs goes down too on about 76% of negative trading days. When market goes up, IPO ETFs go up to in a rate of about 63% of positive trading days. The opposite behavior is displayed by the benchmarkadjusted return of ETFs. This means that when the market goes down, the benchmark-adjusted returns of ETFs moves upward in a rate of about 68% of days and when market returns increase, the benchmark-adjusted performance of ETFs declines in a rate of about 65% of days. A similar one to benchmark-adjusted return's behavior is the case for abnormal returns.

To the best of our knowledge, this is the first study on IPO ETFs. Given the convenience of trading with ETFs, the low cost of investing in such products, the high liquidity of the ETF market in general and the great interest of investors and

#### *IPO ETFs: An Alternative Way to Enter the Initial Public Offering Business DOI: http://dx.doi.org/10.5772/intechopen.90269*

researchers in IPOs, our study should be highly welcome by the investing community and researchers. In addition, the positive initial returns and, even more importantly, the significant buy-and-hold returns revealed by our study should help investors plot profitable trading strategies. Finally, the results of the market trend performance analysis could also help investors implement strategies with mighty potential of substantial gains.

The remainder of this chapter is structured as follows. Next section provides a brief literature review on IPOs performance in the United States and other international markets. Section 3 develops the methodology used in our empirical investigation. Section 4 describes the data used in this study and provides information about the trading features of the sample's ETFs. The empirical findings of our research are presented in Section 5 and the conclusions are discussed in Section 6.
