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Investors who want to grab a hold of the resurgent IPO market, but have neither the time or financial muscle to grab all the hot offerings, have an option in the exchange-traded fund market.

Yet the First Trust may give buyers very little of what they expect, unless they take a close look at the fund's holdings and offering documents.

First Trust's fund seeks to replicate the performance of the IPOX-100 U.S. Index, one of a handful of indexes from a small Chicago-based shop, IPOX Schuster LLC.

The selling point of the IPOX index is that it takes a long view of initial public offerings, buying them after their debuts and holding them for at least 1,000 days, unless they drop out during a quarterly rebalancing that ranks the IPOs by market capitalization. The idea, index creator Josef Schuster says, is to create a broader, buy-and-hold equity strategy than just flipping hot IPOs.

Yet there are a trio of rules to the index that may cause potential buyers to furrow their brows when looking at the holdings.

One is that non-U.S. companies are excluded even if they trade on U.S. exchanges, eliminating a number of hot Chinese offerings. Another is that while new IPOs are added to the IPOX Global Composite Index seven days after their debut, the stocks aren't added to its smaller sister indexes, like the IPOX-100, until the quarterly rebalancing. Additionally, Mr. Schuster makes spinoff offerings eligible for inclusion.

The result? There have been 23 IPOs in 2010 that have returned at least 10 per cent since their issuance, according to Renaissance Capital, a research firm that tracks offerings. (Renaissance Capital operates an IPO mutual fund that buys at offering time, or up to 10 years after an IPO.) Of those 23 top performers through Tuesday, the First Trust US IPO Index Fund held just two of them - Primerica Inc. and Tesla Motors Inc. - at the end of trading. The two made up 0.92 per cent of the fund, less than the 1.25-per-cent holding of Tim Hortons Inc., a company no one thinks of when the words "IPO fund" are uttered.

Instead, the fund's top three holdings on Aug. 31 were Philip Morris International Inc., Visa Inc. and MasterCard Inc., together representing nearly 25 per cent of the fund.

MasterCard went public in May, 2006, more than four years ago; Schuster says it's due to be purged in the next quarterly rebalancing. Visa and Philip Morris both made their debut in March of 2008, the latter as a spinoff from Altria Inc.

All told, Mr. Schuster says, 11 spinoffs, led by Philip Morris's $97-billion (U.S.) worth of market cap, represent 30 per cent of the index. They also crowd out 11 smaller, more traditional IPOs.

The smallest stock in the fund, at about $500-million in market cap, is rue21 Inc., the retailer that made its debut last November and has since erased most of its sizable after-market gains. It is a candidate for the axe at the end of this quarter, Mr. Schuster says.

He says he includes spinoffs because "the evidence is they have been doing very well, and they also make the index larger and more diversified."

Francis Gaskins, a research analyst who operates the website IPODesktop.com, says the sundry rules for the IPOX 100 U.S. Index combine to make the First Trust ETF a less-than-appealing investment for the investor targeting true IPO gains.

"If people want to invest, they should look at the holdings and make sure they're comfortable with them," he said. "There aren't any hot tech stocks in here."

"I think the IPO name is kind of misleading," Mr. Gaskins added. "Technically it is, but it's not really what you think."

Special to The Globe and Mail

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