Super funds cautioned against IPO exuberance
The value-add from Initial Public Offerings (IPOs) for Australian superannuation funds is far less than the anecdotal evidence would suggest, says global implementation manager Parametric.
In a 6-page research report, titled “Anecdotes versus evidence: The institutional case for IPO participation”, Parametric says: “Our findings cast doubt on whether Australian equity managers, leveraging relationships with lead IPO managers (brokers), are really adding value to superannuation fund portfolios.” The research recognises that some exceptional managers should be able to prove their IPO participation adds value through superior selection or allocation, but argues that many managers will not be able to make this case.
“Even when the fund manager is highly skilled in selecting which IPOs to participate in, or able to secure a surprisingly generous allocation to new shares, it is difficult for IPO participation to add meaningfully to performance once all costs are factored in.”
“This takes much of the gloss off racy IPO anecdotes that the industry loves to share and reveals a much more reliable, evidence-based alternative path available to a superannuation fund: to pursue simple, nuts-and-bolts best execution and transactional efficiency without favour or generosity to any particular broker.”
The report, co-written by Raewyn Williams, Managing Director, Research (Australia) and Mahesh Pritamani, Senior Researcher Parametric, questions the assertion by some Australian equity managers that access to IPO “deal flow” is a valuable component of their management style as they seek to benefit from the discretion lead managers exercise around IPO access.
They measured the closing price on the first listing day of all IPOs listed on the ASX for calendar years 2011 through 2018 to show an average return of 5.8% on day 1.
But they add: “Even before considering costs, this headline performance is only a small fraction of the aggregate Australian equity market by capitalisation, muting the performance impact of IPO participation. What must be remembered is that IPO allocation represents, on average, only 0.49% of our hypothetical portfolio over the analysis period.”
“This muted effect means that in our simulations, a portfolio holding a fair allocation of all IPO stocks on listing day only gets an average 3.5 basis points in performance each year from IPO participation. This modest result is hardly the stuff of breathtaking anecdotes and does not indicate that having institutional access to IPOs adds much value.”
The research extends this hypothetical base case portfolio to explore the value of superior selection (which IPOs to participate in) and superior allocation of IPO stocks through the institutional bookbuild process. To even get the annual basis point performance pick up from IPO participation into double digits, the researchers show that the manager’s selection skills or allocation outcomes need to be 4 times better than a typical manager.
Williams and Pritamani further argue that this modest result is weighed down by hidden costs to the superannuation fund which are never raised in IPO discussions. “Because lead IPO managers decide who gets access to the listing, it creates an incentive for the bidding institutional manager to be viewed favourably by them.”
“A common approach, acknowledged by ASIC, is to build up a trading history with these firms, using their broking services to create favourable profiles by directing ‘trade volumes’ or ‘flows’ and paying higher than execution-only brokerage rates to these brokers.”
While this is a legal process, this additional trading cost is no frivolous or immaterial matter.
For the 2011-2018 years, brokerage costs in the Australian equity market averaged 10-20 basis points; that is, for every $1000 of shares traded, $1 to $2 were paid in brokerage costs. Over this same period, execution-only brokerage on Australian equities averaged five basis points (50 cents for every $1000 of shares traded).
“For a superannuation fund client with a $2 billion alpha-seeking Australian equity portfolio and modest 50% one-way turnover each year (100% two-way), this alpha-chasing ‘round trip’ is the difference between paying $2-4 million a year in brokerage and $1 million.”
Williams and Pritimani commented: “Ultimately, we think that some managers can add value through IPO participation, but not nearly as many as claimed. What we want to see, and what we believed is owed to superannuation funds, is a holistic, evidence-based discussion about IPOs, rather than simply swapping a few anecdotes.”
For more information please contact:
Simrita Virk at Shed Connect
Parametric Portfolio Associates® LLC ("Parametric"), headquartered in the United States in Seattle, Washington, with Australian offices at MLC Centre, Suite 6502, 19-29 Martin Place, Sydney NSW 2000, is registered as an investment adviser under the United States Securities and Exchange Commission Investment Advisers Act of 1940. With over $230 billion USD of assets under management as of 30 September 2018, Parametric is a global asset management firm offering investors a variety of portfolio solutions, including tax-managed centralised portfolio management, tax-managed indexing and factor investing strategies, as well as emerging markets and defensive equities strategies. Parametric Australia is a division of Parametric Portfolio Associates® LLC that is a majority-owned subsidiary of Eaton Vance Corp, one of the world's most dynamic global asset management companies.
For more information please visit website: www.parametricportfolio.com.au