Should you invest in IPO by watching grey market premium?

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Grey market premium (GMP) is the most familiar term in respect to IPOs (primary market). It is also the most controversial and debatable term. So, what is GMP? A grey market can also be called a parallel market where shares of IPO are traded outside the official trading channel. If the shares are traded at a premium on its issue price it is called ‘Grey Market Premium’ and if the shares are traded below its issue price it is called ‘Grey Market Discount’.

Components of Grey Market Premium

It is of utmost necessity to understand that how is GMP/discount is derived? Usually, premiums are derived from demand/supply, broader market sentiments, HNI funding cost, issue size and such short term aspects. No-to-negligible emphasis is given to fundamentals.

Accuracy- to what extent?

In FY21, almost 29 IPOs hit the market, out of which major IPOs listed as per the expectations of Grey Market barring few exceptions like- Gland Pharma, Anupam Rasayan, Easy Trip Planners. Usually Grey Market fails in its prediction when market sentiments are overturned suddenly.

Misconception

Many investors, wrongly interpret that- if the Grey Market Premium is strong, then the fundamentals too are strong and vice-versa. As stated above, the fundamentals hardly find any space and much importance is given to sentiments in GMPs. Due to such misconception, investors many times loses an opportunity to invest in quality companies or get trapped in weak companies by taking clues from just GMPs. Also, many investors wrongly construe unlisted/pre-IPO market as a grey market while in reality, both are totally different.

Controversy

The thoughts of market experts are mostly divided in context to using GMP as an indicator. Some find it misleading and not worthy, while some are of the opinion to use it with limited extent as an indicator.

Verdict

Grey market is not backed by legal authorities so obviously one should stay away from trading in it. Secondly, all IPOs are not worthy for long term investment but listing gains may also be possible in such IPOs. Listing gain is also an important reason for participants to apply in an IPO. Here comes the limited utility of GMP which may help as an indicator- only till listing. Just like market participants take clues from SGX Nifty and not trade in it, IPO applicants takes cues from GMPs for listing-price anticipation. Just like any other indicator, GMPs are not full-proof, one should wisely take into consideration- risk-reward, fundamentals, quality of company, expected investment holding period, etc. along with the limited application of GMP estimates.

(The writer is founder of UnlistedArena.com. Views expressed are personal and should not be construed as an investment advice)