Forget Facebook: Why Regular Joes Can’t Invest in the Decade’s Hottest IPO — and Probably Shouldn’t Try

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A thumbs-up marks Facebook's new Corporate Headquarters in Menlo Park, Calif., Jan. 31, 2012.

Even after some disappointing news came to light in the company’s latest public filing earlier this week, investors are jostling to get shares in Facebook’s epic debut in the stock market next month. Fuhgeddaboudit: Individual investors are unlikely to be able to buy Facebook shares before they start trading on the Nasdaq stock exchange.

There are three reasons for this: The big boys are at the front the line, you are at the back of the line, and there is no middle of the line.

Facebook is set to sell between $5 billion and $10 billion in stock for the first time sometime next month. The eight-year-old company has already been trading shares in the private market at levels that would make it worth $90 to $100 billion – about the combined value of its underwriters Morgan Stanley and Goldman Sachs. You would think that there would be enough shares for individual investors to get some of the stock at the IPO price. But there probably aren’t, which is disappointing to investors who are hoping not just for bragging rights but big profits. Anyone who bought Microsoft at the IPO is now sitting on a profit of 34,186%. The S&P is up just 449%. For the record, the underwriters who have been hired to sell the deal can’s speak about their distribution plans or they will get in trouble with the regulators. But in recent years, retail investors have been getting a smaller and smaller portion of shares in IPOs and just token amounts in hot deals.

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“You have to accept that it’s a rigged deal,” says Dave Fry, founder and publisher of the ETF Digest. I had called Fry to see if there was a backdoor entrance to the biggest high tech sale ever.  Not even loyal customers who buy hot and not-so-hot IPOs can count on receiving even a token allotment before the stock breaks for trading. That’s the most desirable time to buy because with white hot deals, the price pops with the very first trade. Anyone who has kept an eye on the IPO market knows what I’m talking about. LinkedIn, the ubiquitous online business networking site, more than doubled last year on its first day out of the gate.  Millennial Media, a hot mobile advertising company, shot up 92% on its first day of trading in March. Yelp, the web consumer-review company, jumped 64% last month as well.

So what’s an individual investor to do?

There are a handful of exchange traded funds (ETFs), closed end funds, and mutual funds that have already invested in Facebook shares or own companies that describe themselves as social media investors, Web 2.0 in the lingo. Firsthand Technology owns about 600,0000 shares of Facebook that it accumulated in the private market. T. Rowe Price owns more than 5% of Facebook, and put a sliver of that stake — about $408  million — in some of its mutual funds, reports Bloomberg News.  Global X Funds runs a social media product, though chief executive officer Bruno del Ama says his social fund can’t buy Facebook shares before the close of the fifth day of trading. And then there are “related” funds, like First Trust Internet Dow Jones Index, which invests in Internet companies that have been trading for at least three months on the public markets. Facebook would also be eligible to join the gargantuan $33 billion PowerShares ETF within three months, the result of a recent rule change at the Nasdaq. Could these possibly make good proxies for Facebook shares—a crack to get in on the action before the IPO?

Joshua  Brown, a financial advisor and author of Backstage Wall Street,  says he is discouraging his clients from scouring around for social media fund plays. “Investors are better off watching the spectacle.” He finds the ETFs piggybacking on the success of social media stocks to be gimmicky — “the Britney Spears of perfumes,” he says. Ouch. Groupon, he sniffs, is a coupon business delivered to your email box. So not Web 2.0 and so in every fund aspiring to Web 2.0 cachet.

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Even if you think the management on these funds is smart, it isn’t a good idea to use them as proxies.  ETF Digest’s Dave Fry likes the First Trust Internet ETF but warns that such funds are volatile — not only because the sector has notable swings but because most are tiny. After Facebook filed to sell stock in February, some of them took off like rocket ships, riding on the wings of hope. In the past three months Firsthand Technology nearly doubled before fading with the rest of the market, up “just” 72%. (The Nadaq is up 7.7% in the past three months after trimming 2.4% in the past month.) Global X Social Media is up nearly 16% in that same time, but with a lot less volatility. It includes big stakes in Japanese and Chinese Internet companies, because that’s where the big growth is, says CEO del Ama.

What about T. Rowe Price? Well, that $408 million Facebook investment is a rounding error when thrown into the $290 billion in mutual fund assets it manages.

“When investors chase returns, they lose,” warns Tadas Viskanta, the blogger behind Abnormal Returns and the forthcoming book of the same name.  He describes these funds as “tertiary” plays – based more on psychology than on fundamentals.

It’s tougher than ever for individuals to make money in hot high tech companies because they incubate for a much longer time, coming to market as grownups. They don’t need to raise money earlier because they don’t need funds to build factories; they can scale virtually and fund on a “just-in-time basis,” says Viskanta.

But take heart. Josef Schuster, CEO of IPOX Schuster, maker of benchmark indexes, says his studies reveal that for long-term holders, playing the first-day IPO pop game is a losing proposition. Stocks that jump more than 40% on the first day of trading generally don’t do nearly as well as the steady eddies.

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