Investors the world over know day-1 IPO returns are usually good. Nowhere in the world are they as good as China though. From 1990 to 2013 the average day-1 IPO return was 118.4%.
In the paper highlighted this week Wei Tang and Liheng Xui from Fudan University and Tianhao Wu from Yale University looked at IPOs in Shanghai and Shenzhen from 2009~2012 to see what else they could observe about the IPO phenomenon.
The period was chosen because it covered a time when authorities weren’t operating restrictive IPO policies and there was no limit to day-1 IPO price fluctuation (limits have subsequently been introduced).
What they conclude is that day-1 IPO investors are mostly individuals with a high tolerance and demand for skewed return payoffs i.e. like lotto tickets with a high chance of small loss but small chance of big payoff. These skewed return preference investors are better known to non-academics as gamblers.
The poor subsequent returns associated with day-1 IPO hotties is explained by the change of ownership that subsequently occurs as the gamblers offload positions to more discerning institutional types who make the head versus heart decisions lacking among previous owners.
The paper contributes to received wisdom by highlighting the very reliable relationship between first day returns and subsequent under-performance. There’s also useful observation here for Sponsors on just how much overpricing is possible in the context of an IPO either being launched at a time of a generally warm overall market or a sector specific rally.
For many years I’ve operated no-IPO and no-stocks-listed-for-less-than-five-years rules. Nice to now have academic backbone backing up at least part of an experienced-based rules system.
You can read the paper in full via this link Chinese IPO Anomalies.
Merry Christmas.