How Investors Should Read into This Recent IPO Frenzy

With COVID-19 cases escalating in both the US and Europe (total cases now exceeds 45 million worldwide) along with the failure of the US Congress to provide a monetary stimulus package, global financial markets had diverging returns last week. Europe’s Euro STOXX 50 index, due to COVID-19, was -1.44% last week and -14.59% year to date. The US market also followed suit with the US’ S&P 500 index down -0.56% last week and +7.26% year to date. Hong Kong’s Hang Seng index in comparison performed strongly +2.18% last week.

AQUMON’s diversified ETF portfolios were -0.03% (defensive) to -0.06% (aggressive) last week and +2.33% (defensive) to +5.80% (aggressive) year to date. AQUMON’s SmartGlobal HK ETF portfolio, with more regional exposure to Hong Kong/China, was +1.08% (defensive) to +10.04% (aggressive) year to date. Last week’s main portfolio drivers were emerging market stocks (+1.39%), Asian ex-Japan stocks (+1.30%), and Chinese treasuries (+1.34%). Beyond US technology (-1.04%), most other asset classes remained relatively flat last week. 

We know many investors are focusing on and clamouring for the ‘deal of the decade’ - Ant Financial’s initial public offering (IPO) next week. An IPO is when a private company lists its public shares on a stock exchange. This week, we will talk a little more about how investors should read into this recent IPO frenzy.

Ant Financial will be the largest global IPO ever

Looking back at history, the previous two largest IPOs were Saudi Aramco’s in 2019 and Alibaba’s in 2014 raising US$29.4 billion (~HK$228.0 billion) and HK$25.0 billion (~HK$193.8 billion) dollars respectively. Ant Financial is set to smash these historic IPOs when it lists on November 5th (next Thursday) and puts the company's value at US$313 billion (~HK$2.3 trillion):

 You may wonder who is Ant Financial and what does it do? Let us explain. Due to increased regulation, Ant Financial spun out from China tech giant Alibaba into a separate entity with a focus on 5 pillars: payments, wealth management, lending, credit scoring, and insurance. The crown jewel in Ant Financial’s payments division is global payment leader Alipay, which currently serves 1.3 billion active users. 

Furthermore, their wealth management division owns Yu’e Bao (translates into “leftover treasure”), which manages over US$157 billion (~HK$1.2 trillion) in assets. At one point in 2018, it was the largest money market fund in the world with US$268 (~HK$2.1 trillion) in assets. So there is a good reason why investors are excited about this upcoming IPO next week, but many investors are mainly fighting to take advantage of the anticipated first day ‘pop’ in stock pricing. We like the medium to long term potential of Ant Financial but caution investors about its short term gains.

Not all Hong Kong IPOs pop much on the first day of trading

It’s true. When calmly looking at 2020’s ‘hottest’ IPOs, large tech names like JD.com and Netease saw an uplift of +3.5% and +5.7% on the first day of trading: 

This is a far cry from the slightly smaller to medium sized companies that saw over +50% jump on the first day of trading. If you have been rushing in to get an IPO allocation because of this, just be careful it may not pan out like you imagined.

Be careful when you use leverage

What happens if you leverage? Then you can amplify the returns, right? We’re glad you asked. Brokerages in Hong Kong are so confident that this IPO will go smoothly that we even see certain security houses are offering up to 20 times leverage to their clients! Using leverage means you are investing on ‘borrowed money’. Given interest rates being at zero to negative levels, this is highly attractive to many investors as the cost of borrowing is extremely low.

A 20 times leverage means an investor could use HK$10,000 up front to invest up to HK$2,000,000! This also applies to returns - when the stock price jumps+2%, you get +40% in return (not factoring in fees) at 20 times leverage.

Investors should be aware that low borrowing costs does not necessarily mean low risk. For an investor using 20 times leverage, a -5% decline in stock price will wipe out your entire initial investment! So please be careful.

Hong Kong IPOs may not jump as much as US IPOs due to regulation and culture

Some investors ask why companies IPO-ing in the US seem to jump more? There are two reasons to this:

1) The US market is more flexible 

The main reason why companies like to IPO in the US is because of its flexibility. Investment bankers that help companies get listed have more power to feel out investor appetite and adjust the IPO pricing beforehand. 

For example, if US bankers feel investor appetite is lukewarm, they could easily adjust the pricing down from the initial range they indicated. Stocks will then more likely pop up more as a result. In Hong Kong, the price range cannot be changed once an IPO deal is open to the public. So regulation plays in part in why Hong Kong stocks do not jump as much on the first day of trading. 

2) More cornerstone investors in Hong Kong 

Culturally it is more common in Hong Kong and mainland China to have ‘family and friends’ (likely similar State Owned Enterprises) invest extremely large orders initially with the purpose of staying invested for at least 6 months. For example, China Huarong Asset Management's 2015 IPO had 70% of its US$2.3 billion (~HK$17.9 billion) offering secured by these types of cornerstone investors. Larger allocation to cornerstone investors means the stock price will be harder to be impacted by regular retail investors.

Two upcoming catalysts for financial markets: IPOs and stimulus

Things may feel quite shaky lately with the US ‘fear gauge,’ the VIX Index +36.4% in the past 2 weeks and closing at levels of 37.59 as of Thursday (which has not seen since mid-April). This is due to a mix of uncertainty surrounding the US presidential election, COVID-19 setbacks and continued trade tensions. Even so, we remind investors that the next 1-2 months will likely be a good opportunity to carefully increase your portfolio positioning as we head into 2021. Why?

We believe risks will slowly unwind in the coming few months. Right now, it might feel like a ‘perfect storm’ is brewing because of multiple market risks clashing at the same time. Investors should understand that in the short term, whatever the result of the US election may be, stimulus will likely follow to provide positive uplift for financial markets. The European Central Bank’s (ECB) has also signalled Thursday night that more stimulus may be on the way in December.

In the medium term, analysts continue to see good probability for a COVID-19 treatment sometime before Q2 of 2021, which means economies can slowly get back to ‘normal’. As we mentioned on our blog multiple times, we live in a unique situation in Hong Kong where we are ahead in the COVID curve relative to our US and European counterparts allowing us to have more clarity in terms of how it may pan out. Although we need to stay vigilant, it is not that scary now given that we have been through three COVID-19 waves. Lastly, locally speaking, we do see the jam-packed IPO pipeline pushing Hong Kong stock pricing and investor appetite up.

Investors just need to be careful not to get caught up in the frenzy and expose themselves to unnecessary risk. Managing your downside risk is still extremely important in this current investment environment even though we continue to see upside. 

If you have any questions, please don’t hesitate to reach out to us at AQUMON. We’re always happy to help. Thank you again for your continued support for AQUMON. Stay safe outside and happy investing!

 Ken

About us

As a leading startup in the FinTech space, AQUMON aims to make sophisticated investment advice cost-effective, transparent and accessible to both institutional and retail markets, via the adoptions of scalable technology platforms and automated investment algorithms.

AQUMON’s parent company Magnum Research Limited is licensed with Type 1, 4 and 9 under the Securities and Futures Commission of Hong Kong. In 2017, AQUMON became the first independent Robo Advisor to be accredited by the SFC.

AQUMON’s major investors include the HKUST, Cyberport, Alibaba Entrepreneurs Fund and the Bank of China International's affiliate.

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