If you find your fund house repeatedly participating in overpriced IPOs, which are losers in the market without any logic, it is better to move away from that fund house
Investors have been raising questions about the rationale behind mutual funds investing in some of the recent IPOs. A look at how and why fund houses bet on IPOs.
HOW DO MUTUAL FUNDS PARTICIPATE IN INITIAL PUBLIC OFFERINGS (IPOS)?
Mutual funds qualify as Qualified Institutional Buyers (QIBs) or participate as anchor investors in an IPO. QIB status provides them with higher allotment certainty as a large portion of an IPO is reserved for QIBs, which is generally 50%. This gives mutual funds a much higher chance of receiving shares compared to individual retail investors, who often struggle to get an allotment in highly oversubscribed IPOs. Mutual funds also participate in the Anchor Investor portion of the IPO, which is a dedicated part of the QIB quota, a day before the main public issue opens.
ARE THERE ANY CONDITIONS FOR MUTUAL FUNDS WHILE INVESTING IN AN IPO?
There are no special restrictions on mutual funds when investing in IPOs, as long as they follow SEBI’s broader investment and risk guidelines for mutual fund schemes. Each scheme must adhere to its stated investment mandate, such as market-cap focus or sector exposure. There is no lock-in period for the QIB portion of an IPO. In the case of anchor investors, 50% of the shares are locked for 30 days, with the remaining 50% locked for 90 days from the date of allotment.
HOW DOES A MUTUAL FUND DECIDE WHICH IPOS TO INVEST IN?
The decision to participate in an IPO is solely based on the judgment of the fund management team. The fund house can decide through which scheme it wishes to participate in an IPO. Fund managers often justify their investment in IPOs by pointing out that this allows them to gain exposure to new sectors, industries, or unique business models that are not available in the secondary market. A new stock could complement their existing portfolio and help the fund house diversify. Finally, fund houses also point out that a single IPO is a very small holding of their portfolio.
SO, WHY ARE MUTUAL FUNDS FACING CRITICISM FROM INVESTORS IN RECENT TIMES FOR PARTICIPATION IN IPOS?
The strongest criticism against mutual funds has been their investments in some of the recent IPOs priced at steep valuations. Some of the recent IPOs have listed or slipped into a discount to their offer price. Critics question whether funds that manage the public’s money are compromising their fiduciary duty and valuation discipline by paying a premium price for these IPOs. They are concerned particularly with new-age or tech-based companies that may have high growth potential but are either loss-making or have very high valuation multiples, sometimes based on sudden, non-sustainable profits reported just before the IPO. IPOs are often a means for early investors and promoters to cash out. Critics suggest that some of these IPOs may be primarily structured to ensure large profits for these insiders, potentially at the expense of new public investors, including mutual funds. They point out that when a fund buys an overpriced stock, the risk of a potential price correction post-listing is passed on to the retail fund investor.
WHAT SHOULD INVESTORS DO?
If you find your fund house repeatedly participating in overpriced IPOs, which are losers in the market without any logic, it is better to move away from that fund house
HOW DO MUTUAL FUNDS PARTICIPATE IN INITIAL PUBLIC OFFERINGS (IPOS)?
Mutual funds qualify as Qualified Institutional Buyers (QIBs) or participate as anchor investors in an IPO. QIB status provides them with higher allotment certainty as a large portion of an IPO is reserved for QIBs, which is generally 50%. This gives mutual funds a much higher chance of receiving shares compared to individual retail investors, who often struggle to get an allotment in highly oversubscribed IPOs. Mutual funds also participate in the Anchor Investor portion of the IPO, which is a dedicated part of the QIB quota, a day before the main public issue opens.
ARE THERE ANY CONDITIONS FOR MUTUAL FUNDS WHILE INVESTING IN AN IPO?
There are no special restrictions on mutual funds when investing in IPOs, as long as they follow SEBI’s broader investment and risk guidelines for mutual fund schemes. Each scheme must adhere to its stated investment mandate, such as market-cap focus or sector exposure. There is no lock-in period for the QIB portion of an IPO. In the case of anchor investors, 50% of the shares are locked for 30 days, with the remaining 50% locked for 90 days from the date of allotment.
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HOW DOES A MUTUAL FUND DECIDE WHICH IPOS TO INVEST IN?
The decision to participate in an IPO is solely based on the judgment of the fund management team. The fund house can decide through which scheme it wishes to participate in an IPO. Fund managers often justify their investment in IPOs by pointing out that this allows them to gain exposure to new sectors, industries, or unique business models that are not available in the secondary market. A new stock could complement their existing portfolio and help the fund house diversify. Finally, fund houses also point out that a single IPO is a very small holding of their portfolio.
SO, WHY ARE MUTUAL FUNDS FACING CRITICISM FROM INVESTORS IN RECENT TIMES FOR PARTICIPATION IN IPOS?
The strongest criticism against mutual funds has been their investments in some of the recent IPOs priced at steep valuations. Some of the recent IPOs have listed or slipped into a discount to their offer price. Critics question whether funds that manage the public’s money are compromising their fiduciary duty and valuation discipline by paying a premium price for these IPOs. They are concerned particularly with new-age or tech-based companies that may have high growth potential but are either loss-making or have very high valuation multiples, sometimes based on sudden, non-sustainable profits reported just before the IPO. IPOs are often a means for early investors and promoters to cash out. Critics suggest that some of these IPOs may be primarily structured to ensure large profits for these insiders, potentially at the expense of new public investors, including mutual funds. They point out that when a fund buys an overpriced stock, the risk of a potential price correction post-listing is passed on to the retail fund investor.
WHAT SHOULD INVESTORS DO?
If you find your fund house repeatedly participating in overpriced IPOs, which are losers in the market without any logic, it is better to move away from that fund house
