A Look at the New Private Equity ETF

by: Richard Kang

The upcoming ETF focused on private equity was a short bullet point from my entry on August 24th. We now have some more info -- here’s what we know from these:

· Roughly 30 positions in publicly traded companies so liquidity is not the same concern as is usual in private equity investing. Although “While the index will hold about 30 companies, Red Rocks says these 30 in turn will have investments in more than 1,000 private businesses.”

· “The new index is a benchmark of about 30 publicly traded companies that invest in businesses that participate in private equity, including private equity firms, business development companies and banks that put the lion's share of their capital into private companies.” I’m interested to know how much of the fund will be invested in the business development companies and banks.

· The composition of the positions is based on the Listed Private Equity Index, created by Denver investment advisor Red Rocks Capital Partners.

· Minimum $50 million market cap for underlying positions. The Street’s article suggests domestic and foreign exposure but nothing more precise than that.

· There will be diversification by sector. “It will include publishing, leisure, retail, biopharma, aerospace, materials and health care, though it will change as the portfolio is rebalanced.”

· Quarterly rebalancing.

· Maximum 10% allocation for single position

· Since it’s an ETF, transparency is another benefit not often associated with private equity investing.

· Expense ratio of 0.7%. This is high in the ETF space but considering how the uniqueness of this product, I would call this reasonable.

For those who follow institutional investors, the Yale Endowment is a name commonly given as a leader in the field. I think that David Swensen’s (Yale’s Chief Investment Officer) books are required reading. His first book, Pioneering Portfolio Management, has a significant focus on the benefits of alternative investing, including private equity.

Take a look at their latest annual report on their website (.pdf).

According to the table on page 8, they have roughly 15% in private equity as of June 2005 with a target allocation of 17%. More detailed description on their private equity work is on pages 20-21. Well worth reading as a first step to those considering the addition of private equity into their portfolio.

The question thereafter is whether an ETF linked to an index is the appropriate vehicle for private equity exposure, or something more like a fund-of-funds. This would be a similar process for an investor in any alternative investment such as commodities or hedge funds.

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