A Is passive investment in IPO’s a viable strategy?

On June 11th, 2007, ET ran an article stating that investing 100 shares in all the IPO’s has resulted in a return of 72%. The following is an analysis on the same question with a different set of assumptions. Some of the assumptions in the article do not suit the general investment strategy followed by most retail investors. Most retail investors do not target owning 100 shares but rather go in for maximum number of shares they can apply in the limit of 1 lakh. And given the widely prevalent belief that the IPO’s are under priced, most of the issues are oversubscribed. The effective investment is then reduced below the 1 lakh limit. The following are the assumptions that are different from the analysis done by ET:

1. Instead of 100 shares in each IPO, the investor applies to shares worth 1 Lakh ruppees


2. The number of shares that the investor has on his portfolio would be in proportion to shares issued on a pro-rata basis if the issue is over-subscribed


3. The analysis will be performed from the view point of retail investors, non-QIB’s and QIB’s


4. The actual allocation is based on lot sizes and the results of an actual portfolio might vary slightly from the pro rata returns calculated


5. The retail investor deposits 1 lakh rupees for a small period of time(approximately 1 month) which also includes an excess amount over the value of shares allocated


6. The current prices that I have used are closing prices as on 20th June, 2007

The 11 issues covered in this year by ET are Advanta India, Asahi Songwon, Bhagwan Banquets (Bhagwati Banquets & Hotels Limited), Binani Cements, Fortis Health Care, ICRA, Insecticides India, MIC electronics, Nitin Fire and Orbit Corp. Some observations regarding these 11 stocks

1. 6 stocks are trading below their issue price


2. 3 issues were under subscribed in the retail segment


3. Out of the 5 stocks at market prices higher than issue price, 4 have holding period returns (HPR) of more than 100%

The result of this analysis shows that a passive investment strategy does give returns of around 17.3% rather than the high 72% as stated in the article. Moreover the non-retail segment following the same strategy would have resulted in negative return of -4.6%. The NIFTY in the same time period achieved a return of 11.2%. Hence in the current market conditions a passive investment strategy into IPO’s is not advisable.

Reference:
http://www.nseindia.com/ : Current prices and issue price
http://www.bseindia.com/ : Current prices and issue price
http://www.chittorgarh.com/ : Subscription details
http://www.moneycontrol.com/ : Subscription details