Bigger is not always better

Posted by Andrew Main 11 August 2016 @ 4:00pm

One of the classic maxims is that bigger is better. When it comes to some kinds of investing, the reverse can sometimes be true.

Most particularly, recent research of new floats by OnMarket concluded that of the more than 1000 IPOs that have gone through the ASX since 2005, the returns from smaller IPOs have been markedly better than from the big ones.

How much better?

Quite markedly, and I’m not just talking Day One, when you get the biggest price moves.

In the year after listing, companies 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.

(If you’re looking at day one performance, it’s plus 15 per cent overall)

The sample of 1049 IPOs is big enough to satisfy any sceptic, and the fact that the smaller players outperformed the bigger ones by just over 70 per cent is nothing if not material.

By the way, the overall average return from IPOs was 9.1 per cent because small offerings were much more numerous than big ones.

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.

Model Jennifer Hawkins is no doubt a fine lady but her very fetching photo gracing the front cover of the Myer Holdings Ltd prospectus back in October 2009 is a 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 Day One) and it’s now bouncing around the $1.30 mark after dipping as low as 83 cents in September last year.

It’s maybe not fair to single out one big ($2.2 billion) dud float as an indication of how the new issue market works, but it is also worth noting that just as big name floats can get investors over excited in the lead up to the day they hit the boards, the tsunami of negative publicity that follows such an event has precisely the opposite effect.

Think McAleese, Dick Smith, McGrath, Vocation and now Wellard.

Meaning, they give floats in general a bad name and even the good ones get tarnished, causing investors to go on a capital strike.

Market professionals now say that the Myer debacle all but closed the IPO “window”, for about three years until 2012.

On that basis it’s still open now, although a significant sharemarket reverse would inevitably close it for a while.

Invest broadly and spread your risk

Another worthwhile conclusion from the research is that rather than trying to “pick winners’” in terms of new floats, it’s more logical to aim for a wider spread of issues and thus reduce risk.

That’s not always easy. For a start, there’s the issue of whether you can actually get an allocation of stock. ASIC put out a report this week (No 486, published on Tuesday) on “Sell-side research and corporate advisory: Confidential information and conflicts” which made it clear that big clients of the investment banks handling the floats get the lion’s share of the stock allocations.

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

And it notes a case where an investment bank offered big allocations of stock to senior management or directors of other companies that the firm managing the IPO was seeking to get corporate business from in the future.

It makes no comment about where retail investors rank, but you can guess. By their very omission, they often don’t rate at all and indeed many prospectuses simply state that “No shares are being offered to the general public.”

But the very fact that ASIC’s noting these things is a sign that things will change, and theOnMarket people are already offering retail investors direct access to a range of new floats via their smartphone app.

They don’t get access to all new floats but because they help issuers to obtain the spread of investors required to satisfy ASX’s listing rules, they get allocations in over a third of them.

That’s not a perfect environment but it’s a start.