If you’ve been listening to financial news the past few weeks, you’ve undoubtedly heard about a slate of upcoming initial public offerings (known as “IPOs”). Given the popularity of the businesses at the center of these offerings – SpaceX, Anthropic, and OpenAI to name a few – it’s no wonder that IPOs are the talk of the town (or at the very least, the talk of CNBC!)

IPOs Defined

What exactly is an IPO? The name somewhat defines itself – it is the first time a private company’s shares become available for trading on the public markets. Companies decide to pursue IPOs for several reasons but mostly, it’s to create a liquidity opportunity for owners/employees/private shareholders (as they can sell their shares in public market after a lockup period) as well as a chance to raise additional capital.

Participation in IPOs

Unless you own shares in private companies before they go public, gaining access to an IPO before it officially launches can be a challenge. Typically, brokerage companies (like Fidelity and Schwab) receive in aggregate a small amount of the share float to offer to their custodial clients. It’s been rumored that the SpaceX IPO is going to allocate far more shares to brokerage firms in hopes of getting shares into the hands of retail investors (rumored to be upwards of 30%). That decision appears to be motivated by the strong (almost fanatical) feelings of a large swath of the general public towards SpaceX’s founder Elon Musk. Brokerage firms allocate any shares they receive to clients but the exact methodology for doing so remains unclear.

As with any investment, potential IPO investors should do their homework and proceed with caution. While IPOs can result in meaningful moves upon their initial listings, they typically underperform the market three to six months out. This can be due to a variety of factors such as waning demand for the shares after the initial “buzz” and sales by insiders after lock-up periods expire. It can also be the very real result of investors confusing love of a product/brand with a sound investment. Of course, this time can always be different. Again, any IPO investment should be carefully evaluated and researched as any stock purchase would be. Information will be limited but a good deal can be learned by studying the IPO filing called an S-1.

Index Absorption

Even if you do not participate in the IPOs directly, you may very well end up being an owner of these IPO businesses in the very near future. Why? Via index fund (or even active fund) ownership.

Let’s look at index funds first. As a reminder, an index fund (whether it be in a mutual fund or ETF wrapper) buys all positions in that given index and weights them on either their market cap (market cap weighted) or by the number of companies in an index (equal weighted). There is no decision to be made – if the index owns them, the index-tracking funds must own them as well.

Given the size of the companies to the market as a whole (more on this below), these IPOs will undoubtedly be a meaningful part of countless index funds in short order. Some of these changes will happen sooner than others. The NASDAQ 100 index (likely as a way to entice SpaceX to list on their exchange) has waived their normal 3 month “cooling off period” and intends to admit SpaceX to their index within 15 days. This will force the hand of index funds that track the NASDAQ 100 to follow suit, resulting in an absorption of $30-40 billion of stock. Other index funds (such as S&P 500 tracking funds) will also have to purchase shares in due course.

Actively managed or factor-based funds (investments that have some decision/stock selection overlay) may also result in other purchases of the shares, depending on the price performance out of the gate.

Staggering Dollars

A final side note – the dollar value of the upcoming IPOs are almost beyond comprehension. The three noted above – plus Google/Alphabet’s recently announced secondary raise – are going to add considerable value to US equity markets. The question is now where this capital come from. Time will tell!

IPOs are an important part of the US capital system. The ones on tap this year stand to be a few for the ages.

Onward we go,