Active investment commentary & analysis

New trend, new issues

This year’s flurry of new issues carries a message; alongside opportunity, hidden risks. Unlike the 2020 bail-out of lockdown-challenged businesses, the new trend is mainly private equity-backed IPOs. High valuations remind us of the value in private markets; great wealth that can be created long before other stockmarket investors can access. Returns on private equity have historically beaten listed shares, but the Woodford saga warns how much expertise is needed for the asset class. Might these new issues have unique challenges even after listing?

The private and public worlds are very different. Transition into the public arena continues some of those risks, but new owners may be less capable of managing them. Behavioural finance recognises the importance of incentives and how conflicts can misdirect behaviour, but typically the new investors at flotation have little influence on this. Indeed, many of the new issues bring in their non-executive directors only shortly before IPO. How much governance can genuinely be brought into the restructuring to meet listing requirements? Often independent non-execs have little influence at this stage, whilst founders and private equity owners set the terms. Certainly, there is IPO research and investor education, but the investment banks and analysts involved in an issue are typically the primary source of information.

MiFID regulation seems to have worsened this informational imbalance. Buy-side active investors are expected to put in work that supports price formation, yet may get possibly small or zero share allocations at launch. Evaluation of ESG is also a public good that largely falls on active managers. Those involved in the issue are rewarded, and passive investors can participate with reliance on the price formation of others. But it can be a poor risk/reward calculation for active managers, even if the "pop” on issue is large. In hot issues, many investing institutions can often receive zero allocation. The Government sees London listing as a post-Brexit commercial opportunity, but maintaining a healthy working ecosystem is what matters, not simply dropping standards.

Woodford has not stopped private equity interests coming into retail investor portfolios. Many funds have sprung up to access this area and the FTSE 100 itself has seen new entrants from the world of alternatives and private markets. Indeed, low cost passive vehicles giving index exposure may now actually embed high cost actively managed funds. But regulation is firmly focused on the listed world; corporates, institutional investors and investment banks. Little of this supervision carries into private equity.

Despite regulation, the boundaries between public and private are becoming more complex and riskier for retail investors. The regulatory line has encouraged crossover investors who help corporates make the transition into public trading. Typically, these are part of the cornerstoning of a new issue that often gets preference in initial allocation. Now there also seems official encouragement for vehicles giving retail investors access into new issues, yet with much more limited rights to information pre-float. Broader share ownership may be a good thing, but the UK privatisation experience reminds us that flotations are often not a good entry point into that investor journey.

And, adding to the change underway, Special Purpose Vehicles to buy into late stage, pre-IPO private equity rounds are helping more institutional investors access at pre-float prices. Special Purpose Acquisition Companies (SPACS) also play their part; effectively shells competing with investment banks to give value to founders and private equity owners. The pace of change and increasing complexity surely demands more review than suggesting the UK might be a light touch home for all this.

Investors buying IPOs from private equity need to recognise how different the two worlds are. Private businesses are dressed up for float, but investors need to look beyond appearances: culture persists.  Governance is often a work-in-progress for years after IPO. This is the challenge for the new stockmarket investors, along with the fallout from conflicts, aggressive incentives and innovative metrics. New issues come with excitement and fantastic numbers; but understanding behaviour may matter more.