A closer look at investment company IPOs

Should advisers and investors consider subscribing for shares in new fund launches, such as an investment company IPO? It’s a question that pits two pieces of received wisdom against each other: on the one hand, we’re routinely told to study the track records of funds and their managers, which is a little tricky with a new launch; on the other, we know past performance is no guide to the future, which rather undermines the case for scrutinising what has gone before.

This dilemma is pertinent in the context of new research published by the investment company analysts team at Numis Securities, which has taken a close look at IPOs in the sector. We’ve just been through something of a boom time, the research points out, with £10.8bn of new funds raised through investment company IPOs between 2013 and 2015. Much of the cash went to funds with an alternative income mandate.

If you subscribe to the track record theory, the lessons from history for those who invested in this boom are somewhat worrying. Numis looked at three other IPO booms of the past 25 years: a spate of funds launched in the nineties to invest in privatisations, the technology bubble at the turn of the century, and the fashion for alternative asset launches between 2005 and 2007. A large number of these funds have not stood the test of time, it warns. For example, almost three-quarters of the 326 new investment companies launched between 2000 and 2009 are no longer in existence, at least in their original form. Admittedly nearly half of these companies were launched on AIM or other specialist markets which clearly have a higher risk profile. In addition, it did uniquely include the period of the worst financial crisis ever. It's one of the strengths of the sector that investment companies have independent boards of directors who able to put a variety of different options to shareholders to vote on. This means we don't see funds lingering on, when they no longer deliver what shareholders want and these figures do demonstrate this.

More positively, however – remember, past performance is no guide to the future – Numis makes a credible case for why this latest bout of IPOs may not suffer the same fate. “Funds launched in the past few years are better positioned to deliver positive investor returns than IPOs in the past, including lower leverage, more competitive fee structures, improved corporate governance and mandates based on delivering a yield from assets with predictable cash flows rather than investing in speculative development,” argues Numis’s Charles Cade.

Cade also points out that investors in IPOs in recent times have tended to be strategic buyers, including wealth managers and multi-asset funds, rather than representing “hot money”. The demand for alternative income hasn’t been a fad, in other words.

We shall see over time, how these IPOs perform. For the time being, they appear to have come to a halt – there wasn’t a single new investment company launch during the first quarter of the year, though secondary fund-raisings have continued at pace. This may reflect the broader stock market volatility seen earlier in the year or even, as Numis suggests, nervousness ahead of June’s referendum on the UK’s membership of the European Union. Certainly the demand for secondary issues suggests there is a continuing appetite for an alternative play on income, which is understandable given the outlook for interest rates.

Back to where we started, then – should you invest in IPOs? Well, the reality is that there isn’t a right or wrong answer. The launches of the past two years succeeded because they offered an asset allocation and investment mandate that met demand from investors; these investors clearly felt these new funds gave them something they weren’t able to achieve elsewhere. That’s a perfectly legitimate reason for subscribing for shares in an IPO, assuming you’re confident the manager can deliver what is promised.