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Lack of Mutual Fund Demand Hurts Small IPO Issuances

A new paper examines the decline of small IPOs in the late 1990s and suggests that the changing preferences of certain mutual funds may have been the driving factor. The authors note that whereas small IPOs constituted 46 percent of non-financial IPOs in 1997, their share had fallen to 30 percent by 1998, and to 10 percent by 1999. The paper suggests that the principle reason for the “persistent absence” of small IPOs is that the largest quartile of equity mutual funds became less interested in the issuances after reassessing the associated liquidity risk.

According to the authors, the 1997 Asian financial crisis and Russian devaluation and debt default in 1998 caused mutual funds to rethink the liquidity risk of these types of IPOs. Additionally, “the accelerated growth of the largest quartile of mutual funds throughout the 1990s and 2000s made liquidity risk ever more salient for portfolio managers given that, as shown in prior literature, portfolio managers typically deploy new fund inflows towards taking larger individual investment positions.”

The withdrawal of these large mutual funds created “a vicious cycle of illiquidity-begets-illiquidty [sic] for small issuers.” As a result of their findings, the authors suggest that any policy initiative aimed at stimulating small IPOs should address the lack of demand among large mutual funds and that initiatives such as the recent liquidity proposal “may inadvertently impose significant barriers for small company capital formation.”