Performance and diversification benefits of IPO‐focused mutual funds

• Published date: 01 June 2023
• Author: Manel Kammoun,Habiba Mrissa Bouden
• Date: 01 June 2023
• DOI: http://doi.org/10.1111/jfir.12323

Received: 14 April 2021

|

Accepted: 22 March 2023

DOI: 10.1111/jfir.12323

ORIGINAL ARTICLE

Performance and diversification benefits

of IPO‐focused mutual funds

Manel Kammoun

1

|Habiba Mrissa Bouden

2

1

Département des sciences administratives,

Université du Québec en Outaouais, Campus

Saint‐Jérôme, Québec, Canada

2

Département de finance et comptabilité,

Université de Sousse, Institut des Hautes

Études Commerciales de Sousse (IHECSO),

Sousse, Tunisia

Correspondence

Manel Kammoun, Université du Québec en

Outaouais, Campus Saint‐Jérôme, 5, Rue

Saint‐Joseph, Saint‐Jérôme, QC, J7Z 0B7,

Canada.

Email: manel.kammoun@uqo.ca

Funding information

Social Sciences and Humanities Research

Council of Canada, Grant/Award Number:

633‐2018‐0052

Abstract

We investigate whether mutual funds that invest in initial

public offerings (IPOs) outperform the Renaissance IPO

Index, IPOX

®

100 U.S. Index, and other comparable equity

funds that do not invest in IPOs. We also explore whether

investors gain diversification benefits by investing in IPO‐

focused mutual funds. Using a sample of active open‐ended

US equity mutual funds, we find that IPO‐focused funds

outperform the Renaissance IPO Index and comparable

funds that do not invest in IPOs. Moreover, they provide

investors withthe benefit of diversificationalong with better

returns. We also find the valueadded by active management

based on IPO strategy.

JEL CLASSIFICATION

G11, G12, G23

1|INTRODUCTION

According to the Investment Company Fact Book 2020,

1

there were approximately 122,000 mutual funds worldwide at the

end of 2019, with a total global net asset value of over US$54 trillion. Most of these funds adopt active management

strategies to better serve their clients and, ideally, generate additional value over their benchmark index. However, there is

some debate about whether active management adds value. Numerous studies (e.g., Barras et al., 2010;Fama&French,

J Financ Res. 2023;46:315–341. wileyonlinelibrary.com/journal/JFIR

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This is an open access article under the terms of the Creative Commons Attribution‐NonCommercial‐NoDerivs License, which

permits use and distribution in any medium, provided the original work is properly cited, the use is non‐commercial and no

modifications or adaptations are made.

© 2023 The Authors. Journal of Financial Research published by Wiley Periodicals LLC on behalf of The Southern Finance

Association and the Southwestern Finance Association.

1

https://www.ici.org/doc-server/pdf%3A2020_factbook.pdf.

2010;Ferson&Chen,2015; French, 2008;Jensen,1968) have found that, on average, active management does not

improve performance when compared to passive management. However, many studies (Berk & Green, 2004;Berk,2005;

Cremers & Petajisto, 2009; Grinblatt & Titman, 1989) demonstrate the value added by active management and explain it in

terms of the manager's ability to develop an optimal investment strategy and produce superior returns. Furthermore,

several studies (e.g., Bekaert & Urias, 1996;Fletcher,2021,2022; Grossi & Malaquias, 2019; Shen et al., 2012)examinethe

value added by active management in terms of diversification benefits rather than performance and find mixed evidence.

One of the investment strategies used by fund managers is the inclusion of initial public offerings (IPOs) in the

fund's portfolio (namely, IPO funds). Fund managers use this strategy to take advantage of an inexpensive and

flexible tool to invest in a large pool of IPOs and the short‐run underpricing phenomenon of IPOs, as evidenced by

the literature (Loughran & Ritter, 2004; Miller & Reilly, 1987). Many previous studies (Ibbotson, 1975; Ljungqvist,

2007; Reilly, 1973; Ritter & Welch, 2002) reveal that underwriters tend to undervalue new issues, resulting in high

aftermarket prices during the initial days of the offering. Therefore, many pre‐IPO shareholders benefit from the

increase in initial IPO prices by selling their shares in the secondary market, resulting in lower stock prices over time.

Other studies, such as Ritter (1991) and Loughran and Ritter (1995), demonstrate that IPOs underperform the

market indices and benchmark portfolios in the long run.

Furthermore, investors interested in IPOs can buy the newly issued stocks directly from the IPO market, for example,

by investing in IPO indices, or they can consider mutual funds, which include IPOs in their strategies and provide diversified

exposure to a wide range of IPOs. Although the number of funds offering exposure to IPOs in their investment strategies

has increased since 1993, most studies have ignored the impact of this strategy on the funds' performance and

diversification benefits. There have been few studies that focus on the performance of IPO‐focusedfundsandthosethat

do focus on specific samples of funds, such as real estate investment funds (Buttime et al., 2005), funds managed by elite

managers (Hwang et al., 2018), and exchange‐traded funds (ETFs) (Rompotis, 2020).

In this article, we examine whether IPO funds outperform comparable funds that do not include IPOs (non‐IPO

funds). Whereas previous studies focus on specific samples of funds, we consider a larger sample of mutual funds.

Thus, rather than being limited to a small sample, our findings can be generalized to all IPO‐focused funds. We

address the following research questions: Is investing in IPO funds a better strategy than investing in IPO indices

(such as Renaissance IPO Index and IPOX

®

100 U.S. Index) and non‐IPO funds (funds that do not have IPOs in their

portfolios)? Do IPO funds outperform IPO indices and non‐IPO funds? Do they provide better diversification

benefits than non‐IPOs funds? The answers to these questions may aid fund managers and investors in determining

the profitability of such a strategy that can guide them in choosing an appropriate investment strategy, which

provides the best performance and is better suited to their risk tolerance.

2|LITERATURE REVIEW AND HYPOTHESES DEVELOPMENT

2.1 |Evidence on management strategy and diversification benefits

Jensen (1968) was the first to demonstrate that mutual funds, despite being actively managed, are unable to

outperform the benchmark. Some studies (e.g., Baks et al., 2001; Berk & Green, 2004; Berk, 2005; Gruber, 1996;

Pástor & Stambaugh, 2002) investigate whether active management adds value and conclude that managers add

value through their active strategies. According to Kacperczyk et al. (2005), fund managers' superior performance is

primarily due to their stock selection ability. Furthermore, Cremers and Petajisto (2009) discover that high‐activity

managed funds outperform their benchmarks even after accounting for expenses and fees. However, according to

recent studies (e.g., Barras et al., 2010; Fama & French, 2010; Ferson & Chen, 2015; French, 2008), actively

managed funds are generally unable to cover their costs.

Several other authors have contributed to the literature onactively m anaged mutualfunds as well as the investment

strategy employed by active managers. Many studies, such as Kim et al. (2000), Brown and Goetzmann (1997), and

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