However, according to Australian equities fund manager Hyperion Asset Management, the low number of initial public offerings (IPOs) need not translate to serious slumps in portfolio performance. 

In Hyperion’s view, the key is to view IPOs and capital markets activity as the exception, rather than the rule. But the IPO habit is one that many, whose fortunes grew with the ‘big deals bubble’ of pre-2008, are finding difficult to break.

“In the last five calendar years IPOs have been running at less than 25 per cent of the average in the five years prior to the GFC,” said Jason Orthman, one of Hyperion’s Portfolio Managers. “And in terms of industrial IPOs, where Hyperion’s interest really lies, the figures are closer to 15 per cent over the same time period.”

Mr Orthman went on to explain that this habit or expectation around IPO-related returns is due to many investors’ experience of boom markets. A boom market can foster ‘hot’ IPOs that deliver short term high returns, often in the first day after listing. He cited examples including the tech boom of the 1990s and the resources boom immediately prior to the GFC.

“However, in the current environment of low credit growth, moderating commodity prices and weak investor sentiment, both economic and capital activity will be subdued. What investors should be looking for is a quality portfolio of stocks that can grind out earnings and dividend growth well above GDP.”

While Hyperion has never relied on capital market activity to generate returns and rarely participates in IPOs, it does monitor the market closely and will occasionally take a stake in growing companies that are evolving into a model that will deliver sustainable long term success.

“Two IPOs we have participated in since 2008 are carsales.com in 2009 and Trade Me Group in 2011. Both are online companies that we understand well through our existing holdings in this space,” Mr Orthman explained.

“We regard IPO investment as the exception, rather than the rule. We think better gains are to be made from early identification of listed stocks whose track record suggests they can grow into ASX300 or even ASX100 companies.”

By way of example, he cites Domino’s Pizza Enterprises, an existing small cap holding with a market capitalization of around $740M that first entered the our portfolios in September 2011 as an ex-ASX300 holding at around $7.00. The stock has since appreciated 52 per cent to $10.65, with the company growing earnings-per-share (EPS) 25 per cent in FY12 and recently announcing a $30M capital return.

Another is Navitas, a mid-cap holding with a market capitalisation around $1.5 billion that is also forecast by Hyperion to produce high double digit EPS growth over the next five years. Its EPS growth in FY12 was -10 percent due to the high Australian dollar, weak overseas enrolments and the acquisition of SAE delivering below expectations. However, with a proven model, global leadership and an improving domestic regulatory environment, earnings are expected to rebound strongly over the medium term.

“Inclusion of stocks that meet our rigorous selection criteria which aims for long term sustainable growth and performance has led to continued strong performance forecasts from our Hyperion Small Growth Companies and Australian Growth Companies Funds. We are unaffected by the IPO drought because our focus is very much on the broader game.”

The post Drought on IPO front no excuse for a go-slow on returns appeared first on AdviserVoice.