New economy IPOs seem to be the flavour of the season. Many clients, especially in the high net worth individual (HNI) and ultra-high net worth individual (UHNI) categories, want to know if they should invest in them. A near 100 percent upside in less than a month, with the possible promise of further gains over the medium-to-long term is a proposition that no investor, or investment advisor, can take lightly.
New economy IPOs seem to be the flavour of the season. The Zomato IPO was oversubscribed 38 times and investors who were fortunate enough to get an allotment gained 53 percent on the listing. There are several other new economy IPOs scheduled over the coming weeks and months.
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Many clients, especially in the high net worth individual (HNI) and ultra-high net worth individual (UHNI) categories, want to know if they should invest in them. A near 100 percent upside in less than a month, with the possible promise of further gains over the medium-to-long term is a proposition that no investor, or investment advisor, can take lightly.
Birth of a new trend
The first point they should be made aware of is that such IPOs represent a high-risk investment strategy. Then, there’s the caveat that all mutual fund advertisements carry: Past performance is no guarantee of future returns. Investors have to bear this in mind: Zomato’s performance cannot be treated as an indicator of the price performance of all new economy IPOs.
What should UHNIs do?
Family offices have invested over $5 billion in the last five to six years in listed/unlisted companies as well as start-ups in India and abroad. By 2025, the Indian start-ups are expected to raise more than $100 billion and the Investment vehicles operated by family offices and UHNIs are expected to contribute more than 25 percent of the same.
Also Read: Why startup IPO can be a good bet
This points to the birth of a new trend in investment that HNIs, UHNIs and family offices, who haven’t yet cottoned on to the trend, have to take an informed call on.
IPOs may not satisfy the requirements of UHNIs, family offices
One has to bear in mind some home truths about IPOs. In any public offer, the advantage is loaded in favour of the issuer – an informed seller is offering shares in his/her company to a less informed buyer. There is a basic conflict of interest as the issuer wants to sell at the highest possible price, while the buyer wants to invest at a reasonable value.
Further, an individual investor will get only a small allocation in a heavily oversubscribed IPO. In most cases, this will not satisfy the requirements of HNIs, UHNIs and family offices
Therefore, this may not always be the best opportunity from their point of view.
Invest through VC funds or recruit experts
Let us be very clear about one thing. Most of these new economy companies don’t earn any profits. This means traditional methods of stock picking – such as price-earnings ratios, return on equity, return on investment and discounted cash flows – will not work.
It will, thus, be more efficient for HNIs/UHNIs/family offices to invest in start-ups through a venture capital (VC) fund where they are not equipped to judge the future prospects of the investee companies.
Alternatively, depending on the size of their corpus, these investors can set up in-house units to evaluate start-ups or go through multi-family offices.
Build your portfolio gradually
We advise clients to become part of an angel network if they want to invest directly. They have to be active participants, conduct due diligence and then invest with their open wide — because there is often no exit option from a bad angel bet.
Here, the HNI, UHNI or family office can take the help of the specialists they engage for the purpose, and that is the right way to proceed. This is an investment in a new class of assets that is expected to generate long-term value for the family office, not a speculative bet that can yield high returns but also go bust.
A few ground rules will help investors avoid pitfalls: They must proceed with caution and build their portfolio gradually. Investors must also spread their bets. For every Zomato or Paytm or Byju’s, there are hundreds of promising start-ups that didn’t live up to their initial hype. For every start-up that becomes a multi-bagger, there will also be dozens that turn out to be duds. Family offices have to hardwire this into their investment strategies.
Be an investor, not a speculator
Investors should take note of the fact that most of these new age companies are largely owned by foreign investors — even though their promoters are Indian. That’s because these foreign investors have seen such companies rise in their home markets and are expecting the same story to repeat in India. That is not the case with HNIs/UHNIs/family offices.
So, instead of putting money on the tactical opportunity presented by these IPOs, HNIs, UHNIs and family offices will do well to look at these companies more strategically. They must come in as an investor, not a speculator.
It, therefore, makes more sense to buy into these stocks over a period of two or three years – whether before or after listing – by which time the market will figure out a way to estimate their real value. That is what we recommend.
—The author, Rohit Sarin is Co-Founder of Client Associates, Private Wealth Management & India’s first Multi Family Office (MFO) firm. Views expressed are personal