With a high‑profile rocket company making its public debut, IPOs have been dominating the headlines again. It’s a natural moment to step back and look at how the IPO process actually works and IPO performance—and why the excitement surrounding these offerings often outpaces the investment reality.
An IPO, or Initial Public Offering, is simply the moment a private company sells shares to the public for the first time. Investment banks coordinate the process, gather demand from large institutions, and set the final offering price the night before trading begins. That price is negotiated—not discovered in the open market—and it reflects institutional interest rather than broad investor sentiment.
What This Article Covers
- How IPO pricing and access actually work behind the scenes
- Why IPO performance often lags in early years, supported by long‑term research
- How index funds may be required to buy newly public companies once they enter an index
- Why rules‑based managers like Avantis delay IPO inclusion to protect investors
- How a diversified, long‑term strategy naturally incorporates new companies over time
The Part Most People Don’t Realize
There are two very different ways to participate in an IPO, and they are not remotely equal.
The first is buying shares at the IPO price before the stock trades publicly. That access is almost entirely reserved for large institutional investors. Most individual investors never receive an allocation.
The second is buying shares once the stock begins trading on an exchange. At that point, anyone can buy—but the price is no longer fixed. If enthusiasm is high, the stock may open well above the IPO price; if sentiment cools, it may open below it. Either way, the first public trade often comes with real volatility and none of the pricing advantages implied by the headlines.
Why the Excitement Often Outpaces the Reality
High‑profile IPOs attract attention because the companies behind them often have bold missions and compelling narratives. But the story and the investment mechanics are not the same thing.
When a company goes public, the proceeds often go toward early investors, existing obligations, or day‑to‑day operations—not necessarily the visionary goals that made the company famous. Newly listed stocks can also be more volatile than established businesses, especially in the early weeks of trading.
A Research‑Backed Look at IPO Performance
The data adds an important layer of context. Research shows that IPOs have historically underperformed comparable public companies for years after listing. Avantis Investors notes that past high‑profile IPOs such as Facebook/Meta and Uber experienced steep early declines, and that “a broad body of research has shown that, on average, IPOs have historically underperformed for some time after listing relative to similar companies that have traded publicly for years.”1
This underperformance persists well beyond the first year. Between 1980 and 2024, IPOs trailed similar already‑listed companies by roughly 2% annualized over the first five years after listing.
How Index Funds Get Pulled In—Whether They Want To or Not
This matters because index mutual funds and ETFs are required to buy newly public companies once they enter the index they track. When a large IPO becomes eligible for inclusion, index funds must purchase it—regardless of valuation or expected return. As Morningstar notes, index providers have been adjusting rules to accommodate mega‑IPOs, and passive funds tracking those indexes “have no discretion in the matter.”
That mechanical buying can affect performance, especially if the stock is added during a period of heightened excitement or elevated pricing.
Why Rules‑Based Managers Like Avantis Wait a Year
Rules‑based managers such as Avantis take a different approach. Because the evidence around early IPO underperformance is so strong, they intentionally delay adding newly public companies for roughly a year. This avoids the volatility, hype, and valuation distortions that often accompany the first months of trading. Avantis highlights that IPOs frequently exhibit early volatility and lagged returns, reinforcing the rationale for waiting.
The Bigger Picture
Your portfolio is built around a long‑term strategy designed for your goals, your risk tolerance, and your time horizon. A disciplined, diversified approach is not reactive to whatever company happens to be in the spotlight this week.
And here’s the part many investors don’t realize: if you hold a diversified portfolio, you may gain exposure to these companies anyway. Many index‑tracking investments are required to purchase newly listed stocks once they enter the benchmark. A diversified portfolio often handles this automatically—without the need to chase headlines.
If you’re seeing IPO news and wondering how it fits into your strategy—or whether it should fit at all—reach out anytime. That’s exactly what we’re here for.