In a few days from now, SEBI is likely to change some of the rules that govern how shares are distributed between different categories of applicants in companies' new issues (IPOs).
Currently, the major reserved blocks are 5 per cent exclusively mutual funds, 45 per cent for qualified institutional buyers (which also includes mutual funds). The exclusive reservation for mutual funds is likely to be doubled to ten per cent. Looking ahead to the kind of money that Indian companies are planning to raise through IPOs during 2007, the five per cent increase translates to a pretty big number. By many accounts, this year could see up to Rs 20,000 crore being raised - this means that mutual fund investors could collectively subscribe to Rs 2,000 crore of IPO stocks instead of Rs 1,000 crore if their fund managers wanted to.
During the current stock market boom, getting an IPO allotment has generally been perceived to be like winning a lottery by investors. Over the last four years, over Rs 30,000 crore has been raised in IPOs and there has hardly been any issue that did not present an immediate opportunity to make a profit. However, making an IPO investment has also been like buying a lottery ticket.
Most people I speak to seem to calculate the IPO returns that they get on the basis of the money that is actually used up for buying allotted shares (if any) eventually. However, your actual investment is inevitably higher since you are not going to be allotted shares for the entire amount you invested. Moreover, in a booming market, there's also the opportunity cost of not deploying the money elsewhere. These factors actually reduce the real excess returns that IPO investment yields substantially.
Do IPOs actually make sensible investments for the retail investor? The fact is that most retail investors invest in IPOs with only a cursory evaluation of which company 'feels' like a good one. And whether they are conscious of it or not, this 'feel' has more to do with how well the company has managed its presence in the media. What passes for an evaluation of an IPO quality is effectively an evaluation of its ad agency and PR agencies' efficiency. The mechanics of an IPO's pricing in boom time is such that this works out, mostly. However, if you are going to play it like a lottery then the logical way of maximising your gains is to apply for every single IPO and sell your entire allotment soon (or immediately) after listing.
Buying into an IPO as a long-term investment is actually quite risky. Or rather, it is the same as buying into any other stock for the long-term with the exception that with a freshly IPOed company, there is generally far less information and track record available. The current bull run is very mature, so the wisdom of holding on to IPO allotment is a suspect. Given many of the factors which I've just listed, it is probably better or the non-seasoned IPO punter to not get directly involved and just trust that the increased mutual fund allocation makes funds a better route for investing in new issues. But then, that doesn't have the added excitement of playing a lottery, does it?