Are new issues making a comeback?

IPOs used to be exciting. Investors would debate whether to buy into young, fast-growing companies as they moved from private ownership on to the stock market with an initial public offer, with high-profile new issues making big headlines. But more recently, the stream of IPOs has slowed, with companies reluctant to list during a period of downbeat market sentiment and many investors sceptical about the hype in sectors such as technology.

However, whisper it quietly, but IPOs may be set for recovery. Data from PwC reveals that IPO activity rose 78% and 359% respectively in the Americas and in Europe during the first half of the year. The consultant reports that there is now a “solid pipeline of companies waiting to go public”. An improving economic backdrop and the fact that a year of elections worldwide is drawing to a close, easing some political uncertainties, may persuade them to take the plunge.

That’s an interesting thought for the many investment trusts that have exposure to privately-owned companies. They are in a position to benefit as those businesses go public, particularly if new issues can be priced more aggressively as confidence returns to the market.

Scottish Mortgage is one such investment trust. Deputy manager Lawrence Burns recently told Portfolio Adviser magazine that he had in recent years encouraged some of the private companies in which the fund invests to hold off from IPOs, for fear of them not realising a full price. Now, however, he sees signs of better times ahead; two portfolio companies have already unveiled IPOs this year.

Another investment trust managed by Baille Gifford is also often seen as a play on businesses that are close to an IPO. Schiehallion invests in high-growth private market companies that are mature enough to consider listing; it has benefitted from holdings in companies such as Wise, the fintech company that was one of the UK’s biggest new issues of recent years.

Schiehallion sits in the AIC’s Growth Capital sector of investment trusts, all of which have a similar mandate. They predominantly invest in the shares of privately owned companies, but they are different to private equity trusts. Rather than taking controlling stakes in the businesses they back, Growth Capital trusts tend to take minority positions, investing at an earlier stage of businesses’ development.

Whether you look specifically at the Growth Capital sector or more broadly at all funds taking stakes in private businesses – including the generalists such as Scottish Mortgage – there is good reason to focus on investment trusts for this kind of exposure. Shares in privately owned businesses tend to be illiquid; that makes them a difficult holding for open-ended funds, which may need to increase or decrease their stakes in a hurry. The closed-ended structure of investment trusts, by contrast, means they don’t have to worry about such issues.

Privately owned companies can generate mouth-watering returns. Their allure is that you’re buying into businesses that are just taking off – and therefore have their best years of growth ahead of them. An IPO then gives you a way to crystallise some of the potential gains – or you have the option of holding on for further growth to come.

The downside is that such businesses can be volatile. They may hit unexpected setbacks, they are often narrowly focused, and they can (and do) fail completely.

Still, an investment trust offers risk management benefits in this regard – you get exposure to a spread of companies. And fund managers hope that it only takes a couple of big winners – potentially via an IPO – to drive returns upwards. Indeed, Schiehallion was the second best performing investment trust across the whole industry over the 12 months to the end of July. Its longer term record is less alluring, underlining the ups and downs of the sector, but Growth Capital trusts could be worth investigating if you think IPOs are set for a comeback.