IPO VIEW-IPOs year to date, a risky bet pays off

By Lilla Zuill

NEW YORK, Oct 26 (Reuters) - Initial public offerings are considered a risky bet by many that typically gets riskier during volatility in the broader market. But IPOs are outperforming the wider stock market so far this year.

IPO experts also say they can be a good way for investors to diversify their portfolios and there are ways to lessen the risk of participating in these offerings.

Investors have endured a bit of a roller coaster this year. A chart of the bellwether S&P 500 Index .SPX, up about 8 percent year to date, paints a picture of some wild swings.

And the VIX, an index which measures expected fluctuations in the S&P 500, has shot up to levels unseen in five years.

In the face of that volatility, U.S. IPOs have outperformed the S&P, according to Josef Schuster, chief executive of IPOX Schuster LLC, a financial services company that tracks IPOs.

Schuster said his firm's benchmark U.S. IPO index is up 13.4 percent year-to-date, and globally new issues have performed even better.

The index is weighted for market capitalization, but does not include two high profile offerings, Blackstone Group (BX.N) and Fortress Investment Group (FIG.N) because they are limited partnerships.

Both have come under pressure because of fears the recent tightening of credit could curb their investment activity.

Schuster said their inclusion would have brought the IPO index down a bit.

Hedge fund manager Fortress is up 13 percent from its $18.50 offering price but trading 30 percent below its first day price of $31, while private equity firm Blackstone is 17 percent below its $31 offering price, at $25.62.

But there have also been numerous bright spots.

"In the U.S. market there have been some very good deals like VMware Inc (VMW.N)," said Schuster.

Software maker VMware gained 76 percent in its first day of trading, and has risen about 120 percent since. Its Aug. 14 debut coincided with a steep decline in the S&P 500.

TREAD CAREFULLY

"IPOs are the riskiest in the equities spectrum," said Kathleen Smith, Chairman of Greenwich, Connecticut-based IPO research firm Renaissance Capital.

But Smith, who tracks the sector's performance with a recently launched industry index, said IPOs can be a good way for investors to diversify their portfolios.

Year to date, 174 companies have launched offerings on U.S. exchanges, a 23 percent increase over the same period a year ago, according to Renaissance.

University of Florida finance professor Jay Ritter said investment in IPOs produces diversification because the offerings disproportionately represent new industries.

But he said investors need to have a few tools up their sleeve to pick between star offerings and possible duds.

Pay attention to financial fundamentals, and invest more heavily when markets are moving higher, Ritter said, as IPOs typically perform better in bull markets -- and look at size.

"As a measure, companies with less than $10 million in sales in the year before going public have historically had abysmal performance," Ritter said.

IPO QUALITY SEEN IMPROVED

Linda Killian, portfolio manager of the IPO Plus Fund, a mutual fund advised by Renaissance Capital, said the IPO market has matured from the late 1990s when investors went wild for dot.com companies, despite a lack of profitability, and fleeting track records.

"The quality of companies is improving, deal size and capitalization are increasing and there are not a large number of unprofitable companies," said Killian.

Those that are unprofitable are close to turning a corner. "They are on the cusp, and investors can see that," she said.

Most of the companies expected to go public in the week ahead have reported healthy revenues, and profits.

They include hotly anticipated Chinese online games developer Giant Interactive Group, which plans to raise up to $800 million and trade its American Depositary Shares on the New York Stock Exchange. Giant Interactive's revenue rose ninefold in the first 6 months of 2007 to 687.4 million yuan ($92 million), while its net income surged nearly twelvefold to 512.3 million yuan.

Of U.S. issues, Herndon, Virginia-based Deltek, a maker of project management software, plans to raise up to $171 million. The company had net income of $15.3 million in 2006 on revenue of $228.3 million in 2006, compared with a profit $8.7 million a year earlier, on revenue of $152.9 million.

"It certainly is not the exuberance of the Internet bubble of the 1990s," Maria Pinelli, director of Americas for Ernst & Young's strategic growth markets, said. "It seems to be a very well measured market, investors are only rewarding well performing companies with solid business plans."