IPO Frenzy: Are Your Mutual Funds Betting on the Wrong Horses?

Easy liquidity and growing interest from retail investors enabled bumper listing for many of these stocks. They also gained popularity because of their ability to potentially disrupt the sector in which they operate.

However, barring a few, most of the IPOs are currently trading well below their issue price. Of these Paytm shares eroded investors' wealth the most; its stock price has slipped by over 60% from the listing price. Other new-age tech stocks such as Zomato, Policy Bazaar, Nykaa, CarTrade Tech have also shed about 30-60% post listing.

Few others such as Fino Payments Bank, Nazara Technologies, Suryodaya Small Finance Bank, Krsnna Diagnostics, etc. have also plummeted sharply from their peaks.

Interestingly, mutual funds did not shy away from investing in these IPOs even though they were expensively priced with low clarity on earnings growth. Few stocks such as Paytm and Zomato have not even turned into profitable entities yet.

As per media reports, at the higher IPO price band of Rs 2,150 Paytm was valued at EV/revenue of 40.3 times (in FY21). In comparison, its profitable foreign-listed peers such as Paypal Holdings, Ant Financial, and Square Inc. trade in the range of 7 to 12 times.

Similarly, Zomato was priced at 15 times its FY21 EV/revenue which is stretched compared to its global peers such as DoorDash, Just Eat Takeaway, and Meituan that are trading at 4x-12x.

On the other hand, Nykaa's share prices plunged lower compared to many of the recently launched IPOs. It is one of the few profitable Unicorns in India and appears well-positioned to grow at a healthy rate in the coming years.

IPOs are usually launched when there is optimism in the market, causing investors to overemphasise the price factor instead of value. It is no wonder that when market conditions turned weak, expensively priced IPOs and other stocks got a reality check and have corrected sharply.

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Do mutual funds still hold exposure to recent IPOs?

Despite the sharp plunge in prices, many mutual fund schemes continue to hold them. In fact, few Mutual funds have increased their holding in some of these stocks, perhaps taking advantage of the price correction. Motilal Oswal Mutual Fund, Aditya Birla SL Mutual Fund, Kotak Mutual Fund, Mirae Asset Mutual Fund, and UTI India Mutual Fund are among the prominent fund houses that hold higher exposure to the recently launched IPOs.

Do note that some market experts are of the opinion that it is not the end of the pain for investors in these stocks as there are chances of further correction due to stiff competition, high valuations, and complicated business models in some cases.

Will new-age tech stocks continue to erode the wealth of mutual fund investors?

New-age tech companies have the ability to disrupt the sector in which they operate and emerge as leaders. However, they are in the early stages of the business cycle and may require a long-term time frame to turn profitable on a sustainable basis.

In such a case, it would have made sense for mutual funds to adopt a wait and watch mode for more clarity to emerge on their earnings growth and scalability, and subsequently invest when the valuations are favourable. But it appears that some mutual fund houses got carried away by the greed of making a fast buck in an overheated market through IPOs.

Thankfully most schemes have a low allocation of less than 2% in these stocks combined. Investments in other shares can more than make up for mark-to-market loss in the IPO. That said, if these mutual fund schemes have adopted a similar approach while picking other stocks in the portfolio, it is a cause for concern.

Equity mutual funds are meant for long-term investment. Therefore, investing in IPOs for quick gains is not a sustainable strategy. The only way to maximise returns from equities is to pick financially sound companies with strong business models and stay invested for the long run. Mutual fund schemes that are selective about the stocks in their portfolio and are conscious about the price they are willing to pay can be expected to perform well consistently.

What should investors do?

A stellar IPO listing does not always reward investors over the long term, often gains fizzle out soon after the initial listing. Similarly, a stock that lists at a discount to its issue price does not mean it lacks potential, because stocks can recover losses overtime and reward investors.

While mutual funds need to look for emerging opportunities in a particular stock/sector/theme, as an investor, one should avoid investing in schemes that frequently take momentum bets to boost short-term gains. Frequent churning adds to the volatility of the portfolio and increases portfolio expenses, which in turn can impact overall returns.

Ideally, one should invest in mutual fund schemes that focus on the stability of business operations, competitive advantage, sustainability of the business model, and healthy financial performance, among other parameters, while selecting stocks for the portfolio. The scheme should hold quality stocks with conviction until their full potential has been realized, so that it can provide investors with optimum long-term growth of capital.

Remember that portfolio characteristics of schemes are as important as the performance record, and investors must give these aspects adequate weightage while selecting worthy schemes for their portfolio.

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Warm Regards,
Divya Grover
Research Analyst