Money Life with Chuck Jaffe: IPOX® CEO Josef Schuster on the IPO Market

IPOX® CEO Josef Schuster sat down with Chuck Jaffe on his brilliant Forbes top-rated podcast Money Life with Chuck Jaffe to discuss the state of the IPO market, its strong performance amid market highs, and the factors driving its momentum. Schuster highlighted the role of low interest rates, robust earnings, and the rise of sectors like AI and industrials in fueling IPO growth. He explained IPOX's investment approach, which focuses on newly public companies during their first five years, and emphasized the long-term benefits of including IPOs in diversified portfolios. Additionally, Schuster shared insights on market trends, IPO risks, and his optimistic outlook for 2024.

Listen to the Podcast here:

Full Transcript:

Chuck: Welcome to the Big Interview on this edition of Money Life. Joining me now, Josef Schuster, the Chief Executive Officer at IPOX Schuster. It is IPOX - I - P - O - X which is important because if you want more information on what they do, IPOX.com. But IPOX Schuster... the IPOX... I.P.O. - Yeah, we are talking IPOs today because Josef Schuster is pretty much the preeminent watcher of IPOs. If you want to learn more about what they do, it's IPOX.com. By the way, if you want to invest in IPOs, they are involved in a couple of different ETFs: the First Trust U.S. Equity Opportunities ETF (FPX) is the domestic IPOX 100-based ETF, but then there's an international version (FPXI) and a European-focused version (FPXE). So if you're looking at “how to I add IPOs to my portfolio”, that would be what you'd be looking at. Josef Schuster, it has been a while. It is great to have you back on Money Life.

Josef: Thanks for having me, Chuck.

Chuck: I'm not sure we could have picked a better time to be talking IPOs because very quietly, right, amid a market that's been reaching record highs, well, IPOs as measured by your index have also been reaching record highs. So help us understand, why is the IPO market doing so well right now?

Josef: IPOs have been, I think, a big beneficiary now of the low interest rate environment, especially the expectations about inflation are coming back. That has kind of built the momentum back into the IPO market. That's first. Second, obviously overall markets are helping. But third, what's really interesting is, especially this last earnings season which just passed around, earnings amongst IPOs, amongst these relatively unseasoned stocks which we invest in, have really been tremendous. More than 75 percent of our holdings, for example in the IPOX 100, have beaten on earnings and sales while the S&P stands around 60-65 percent. So that has really driven huge gains over the last two months.

Chuck: Are there specific areas that are really pushing this? I mean, everybody wants everything that's tied to AI, etc. Anytime you get an area of the market that is hot, you wind up seeing things change when it comes to what's coming public. Is there anything specific that is driving this, or is it just, you know, every now and again the market really gets to where it favors and loves IPOs?

Josef: AI is definitely a key theme. What we have been measuring, whether it's a Palantir or whether it's AppLovin, we are still heavily involved in those companies. So they've had huge gains as the market has been broadening out from the FANGs and from these heavy Microsoft names and Googles of the world into broader exposure from AI. That's been definitely driving it. What's been also interesting is, you know, because we add spinoffs as well into our portfolios, industrials have done really well. We talk about a Carrier, we talk about the GEV (GE Vernova), we talk about other companies in the industrial space, and these companies actually have been outperforming some technology companies quite remarkably as well. So the positive move has been driven by companies across the universe, not just AI-driven but definitely older economy names as well.

Chuck: Let's help make sure that everybody understands what we're talking about here. Because obviously IPOs, people think "yes, it's an IPO," but for you, this is not about "let's track an IPO as it goes through the initial pop." You know, oh, it came out, the market loved it - which doesn't always happen, but that's the hope everybody has. It'll come out and get a pop and then it will go on. How long to you is an IPO an IPO? I mean, at what point is it now new enough that it's no longer really an IPO?

Josef: We look at this universe of stocks on a global basis for the first approximately five years of going public. What we do, we pull companies which have this big uncertainty about the value together, which include IPOs, spinoffs, De-SPACs as well, and we look at those as one equity sector for approximately the first five years of trading. What investors get with the IPOX indexes is exposure to these very new companies, and the advantages that this active shares overlap with the benchmarks and competing funds as well is very very little. What you get eventually for certain products is a true asset allocation benefit.

Chuck: Numbers when it comes to the stock market - the number of stocks has been shrinking. What has been happening to IPO activity? Because it tends to run not necessarily in cycles, but there are times when nobody wants to come out because the market is such a tough thing. You kind of go, "let me keep making my money or raising my money in other ways." But like, we're in a changing rate environment. So in terms of IPO activity generally, where does this rate? Like, we understand yeah, the index is at all-time highs or near all-time highs, but what's the activity level right now and what do you foresee happening as we go through this rate change environment?

Josef: We had had a decent number of IPOs in the U.S. this year, more than abroad, less than in the heydays two or three years ago. But we talk about 150 to 200 companies going public this year alone. Obviously, numbers - it has been a long time from the heydays 20-30 years ago, but we still work with significant large numbers of companies going public. The interesting bit, I think, for an investor nowadays, these companies which go public, they're older, they're more mature, they have gone through a number of financing rounds, and therefore the quality of deals actually has gone up significantly, which is reflected in the performance of our indexes as well. What's really interesting from the numbers is also that the default, like the risk of bankruptcy of an IPO nowadays once it's public, it's actually quite low. So this risk actually has shifted to investors in the pre-IPO markets, while post-IPOs haven't gone bankrupt at all. It's just been really an interesting development to see, and that has really fed into this very strong performance of our indexes over time.

Chuck: You and I go way back, but I do remember a time when there were more IPOs that were headed for trouble. And while it doesn't seem to happen now, there are still IPOs that they're fluffed up by a market that's really anxious to offload what they've got. Is it that it used to be that for a company that could foresee trouble, going public was the last resort? Because of course once you go public, you got to bring in all the stuff where you got a lot more oversight and all the rest. So it was last resort, and now it's not so much last resort, or even if it is last resort we can't tap the private markets for more money. It is still a case where the companies, because they're that much more mature, they're not going out immediately like we're not seeing the "oh here's Pets.com, huge flash in the pan and then out"?

Josef: Yeah, that's true. Again, I think that was one of the biggest beneficiary of the Sarbanes-Oxley Act. While the investment bankers are complaining about the number of companies out there, I think as an investor that's all you actually wanted to see because Sarbanes-Oxley enforced companies to report better, to have more stringent regulation around them, better accounts as well. And that again, Chuck, I can repeat myself, has fed into the performance of companies being public. Our IPOX 100 index, for example, which is the underlying for the FPX ETF, runs at almost 300 basis points of outperformance annually over the last 20 years. Now again, Sarbanes-Oxley, less IPOs actually has been better for the investors, better to achieve asset allocation benefits, and really the risk now has been shifting to the pre-IPO market in terms of the big risk in IPOs of default.

Chuck: I should point out, you know, you talk about overperformance - the IPOX 100 US is up almost 35% as we record this year to date, and as much as this has been a good year for the market, it hasn't been that good for the broad market. So that's part of why you want to do this. But I'm curious because it does appear, if I look at assets in the funds etc., that interest in IPOs in terms of "I could add IPOs to my portfolio," that interest is down. Your international funds are much smaller - I don't know if that's a reflection of international investments, but even with the good performance, your domestic fund has less in assets than the last time we talked. So what is driving that? Why, if you've got the long-term outperformance in your pocket as this is why you'd want to do this - you know, the money doesn't lie - why is the money saying we're less interested?

Josef: It's a lot of investor education as well, Investors may be confusing the ETFs and the IPO investment strategy with interest in IPOs. I think there's “no IPO, IPOs are down in terms of activity, therefore I don't need an IPO ETF or FPX or an IPO investment vehicle”. However, what we are really in the business of is we are promoting the concept of indexing, average exposure into this new listing space overall, the IPO story, and that you have to make it part of your asset allocation because it can give you this active share and this alpha over time - what you should have in terms of expanding your opportunity set in your portfolio. It's a lot of education what we are doing. We are out there talking, hopefully flows are going to increase again, and those indications are they are increasing, and we look forward to a strong year next year.

Chuck: You have IPOX indexes that cover Asia, China, etc. You've got thematic IPOX indexes as well. How much are you worried about things like tariff policies and the potential for trade wars? And does that have a particularly big impact or potential impact on IPOs? You've got nascent companies that suddenly could have an additional headwind - what does that do to the market?

Josef: I think we are less concerned for the U.S. and for Europe about trade policies. I think Europe won't be affected that much. I think the U.S. itself, if you are worried about impact on trade policy on IPOs - if you deal with China especially, we're not a big fan of Chinese IPOs. Those have a huge default risk around them, they trade very wacky. So we are not really concerned about macroeconomic trade policies and so forth. In fact, our favorite names or our favorite companies are the true domestic U.S. companies which probably nobody hears about in the first place - like Orion Specialty, ULS Solutions, this Landbridge Energy companies, these small and mid-cap U.S. IPOs, these good old traditional deals which go public and are domiciled here, and those on average, they always outperform the market significantly.

Chuck: It's interesting to hear you say that because of course many of those deals are small cap deals. Small caps have lagged as the market has been dominated by the giant names. Why have small cap IPOs outperformed small caps in general as an asset class?

Josef: It's a buyer's market in IPOs. The conventional wisdom around IPOs these days is they're risky, they may underperform the market. Companies go public, they still need to raise money. It's a buyer's market - they price conservatively, probably raise a little less money than what they need, but they price conservatively. And with a very strong U.S. domestic economy and the interest rates coming down, earnings of many of these companies have exploded three, two, three, four years out after being public, and that has been really driving our performance recently. Last week we were up almost six and a half percent alone - huge relative moves. Again, it's an earning story. It's really interesting that this universe of companies which represents a new generation, the IPO companies, on our earnings sales front have really really done well, something which is really different than two, three years ago at the height of the Corona bubble, if you want to say. Again, we believe that's here to stay.

Chuck: You know, we talked the classic IPO pop that companies get. We have seen much less of that in recent times. You still get a couple of names that get out there, and you've got a number of new companies like a Snowflake, for example, or Symbotic, which have both, I know, exceeded sort of everybody's expectations. But is it better as an IPO investor to not have the pops? In other words, while that's what everybody looks for, those are the cases where IPO in my book always stands for "It's Probably Overpriced," right? Like, is that - are we better off when we're hearing less about the IPO market because we're not going "look at this new thing that came out of the box and doubled in the first day and a half"?

Josef: What we believe, investors and we are staying away from companies which are overhyped, which is obviously a reflection of the IPO pop. We typically don't take companies which are doubling on the first day for consideration into our portfolios. However, a company typically - the numbers say that companies which are in the 0 to 15 percent initial return range should be invested in. Obviously, a company wants to have a strong pop as well in order to leave a good taste in initial investors' mouths, in order to get attention on the market, which has some tremendous marketing benefits as well. So usually this IPO pop is some signal - from a data perspective, the best performing IPOs are between zero and maybe 17 or 20 percent higher after the first close, and then we usually step in and buy respective exposure. With our ETFs, we don't buy companies at the offering price. We really care about the long run four to five year exposure to this name. So as you want to say, we don't care whether Google opens at 70 and then we flip it at 85 - we want to buy it at 110 and run it over time, and that's kind of how you make the bigger money in IPOs, holding. We are systematic quarterly rebalancing process rather than trading in and out on the first day.

Chuck: Obviously IPOs do better when markets are doing well. We've had two really strong years on the market as we come to the end of this one and still room to run, but you know, Santa Claus rally and the rest - people are expecting this year to finish strong. What's your general market take at this point? I mean obviously when the market is moving in the right direction, IPOs benefit dramatically. When the market starts moving in the wrong direction, IPO activity quiets down. But are you worried that there's a correction, there's something coming that is, you know, in the not too distant future?

Josef: I'm not worried for the market as a whole. I think it's strong, earnings are strong, rates are coming down, inflation expectations are coming down. I think the only risk is some kind of shock, economic shock from outside which could refuel inflation. But I think the Federal Reserve has done a tremendous job getting things under control on the inflation front. If inflation is under control, everything else should be smoother sailing. That should reflect, be reflected in strong earnings again eventually. I guess it can be another 10 to 15 percent up next year in the benchmarks.

Chuck: Well, we certainly would be pretty happy if that's what happened, and of course we'll be watching not just the market but the IPO market as well. Joseph, it's always great to catch up with you. Happy holidays, thanks for joining me on Money Life.

Josef: Thank you for having me, Chuck.

Listen to the full podcast here: https://moneylifeshow.libsyn.com/ipoxs-schuster-says-the-ipo-market-can-stay-hot-into-next-year