Are mutual funds a better way to invest in IPOs?

he year 2021 has been a remarkable year for the primary markets in India. As per data available with exchanges, 53 companies have been listed on the main board compared with 14 in all of last year Additionally, the Securities and Exchange Board of India (Sebi), recently approved draft papers of 10 more firms, meaning the strong momentum in the IPO market will likely continue.

Returns wise, 2021 has also been historic, as several companies more than doubled investors’ money on debut against the issue price. For example, Sigachi Industries Ltd spiked 270% on market debut, Paras Defence And Space Technologies Ltd surged 185% on the listing day and Latent View Analytics Ltd jumped 148%.

However, investing in IPOs for listing day gains can be a tricky affair. Data shows that out of 53 IPOs till 29 November, 37 companies reported gains on the first day of listing, while 16 saw losses.

Among notable losers, One 97 Communications Ltd (Paytm) lost more than a fourth of its value on listing, while Kalyan Jewellers India Ltd and Windlas Biotech Ltd slumped 13% and 12%, respectively on market debut.

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The picture doesn’t improve post listing as 15 companies out the 53 debutants this year are still in the red compared to their issue price.

IPOs are usually launched when there is a market surge, and as promoters aim to limit dilution of value, the valuations are generally at a premium. This leaves little value for small investors. Therefore, experts suggest that looking at the do-it-yourself (DIY) approach to make quick money through listing gains, the difference between the face value and the price at which it lists, is not a greatest strategy.

However, taking a mutual fund route may cut down on the risk for retail investors for taking exposure to IPOs that can tend to be volatile and also ensure of allocation of shares, which becomes difficult when it comes to popular issues.

Edelweiss Asset Management Ltd’s Recently Listed IPO Fund is one such option. The scheme was earlier a close-ended fund—Edelweiss Maiden Opportunities Fund – Series 1 (EMOF)—which was in June 2021 converted into an open-ended fund to become India’s first open-ended fund focused on investing in 100 recently listed IPOs.

The EMOF was launched as a close-ended fund in February 2018, with a tenure of little more than three years, which ended in June. The fund has assets under management (AUM) of around ₹900 crore (as of 30 October) and has delivered a return of about 22% since inception.

According to the fund house, the scheme invests in the best 30-40 ideas from 100 recently listed and upcoming IPOs with bias towards small- and mid-cap stocks.

Another fund house, Motilal Oswal Asset Management Co. Ltd, has applied for S&P US IPO and Spinoff Fund of Funds with the markets regulator, and will invest in companies listed in the US.

Suresh Sadagopan, founder, Ladder7 Financial Advisories and a Sebi-registered investment adviser, who doesn’t recommend IPOs, said, “I don’t see great merit in mutual fund route either. You cannot really predict which IPO will come and what kind of companies in which sectors will launch their IPOs; you cannot predict anything. You will have to go with whatever IPOs are coming in. if you look at today’s IPOs, none of the them are exactly priced so that investors are assured of listing gains.”

According to Sadagopan, even if there is merit in investing in an IPO, one should wait for at least six months for the true price discovery to happen.

However, some experts believe that the mutual fund route provides access to a large number of IPOs with limited money and also reduces the risk of higher exposure to a few stocks.

Deepali Sen, founder, Srujan Financial Services LLP, who doesn’t recommend direct IPO exposure, said, “The mutual fund route reduces the risk as it is diversified. Funds are probably 1-2% invested in an IPO that has come out. So, mutual funds can reduce risk, one, by being diversified and second, they are run by professional managers. So, they are not going to rush into things just based on the visibility or the excitement the IPO is generating during launch. Fund managers obviously will look at the fundamentals.”

According to Sen, since most IPOs are overpriced, investors would be better off going for a normal mutual fund.

“Most of the schemes can have 5- 10% of their overall investment in IPOs, or take a call whether you want to invest or not after seeing a couple of quarters performance after the IPO collects money,” Sen said.

Even if you are convinced about the fundamentals, you need to remember that you must give time to the company to perform.

Investors should also note that experts believe that the present exuberance may be getting over soon, at least in the near term, and weak performance of the stock markets may hit the prospects of the upcoming IPOs.

The BSE Sensex may have seen a decent run-up this year as it is higher by 19% on a year-to-date basis. However, given pricey valuation, rolling back of stimulus by the US Federal Reserve and emergence of new variants of covid-19 virus, the benchmark is down around 5% on a one-month basis. Some experts feel that the correction may continue for some time, if the latest variant of covid virus, omicron, results in latest round of lockdowns or restrictions.

Financial planners also advise against investing in IPOs as the investment pie for retail investors is usually very small.

Investors should also keep in mind the taxation aspect. The gains in mutual funds for a holding period of less than one year is treated as short-term capital gains (STCG), and are taxed at 15%. The gains over a holding period of more than one year is treated as long-term capital gains (LTCG) and are taxed at the rate of 20% post indexation. LTCG of up to ₹1 lakh is tax-free. On the other hand, in stock investing, irrespective of your tax slab, STCG (less than one year) is taxable at 15%. On the other hand, LTCG (more than one year) of over ₹1 lakh is taxed at the rate of 10%.