BGI Announces a New Private Equity ETF: Should I Even Bother?

I’ve focused so much lately on the small up-and-comers in the ETF space although I try to find reason to give kudos to the giants when they pull off something different. The recently launched infrastructure ETF from SSGA is one good example, but as Roger Nusbaum has mentioned, it’s really more of a global utilities fund.

So I find from the Financial Times news of Barclays Global Investors’ new private equity ETF that should have begun trading yesterday. Something to go up against PowerShares Listed Private Equity ETF (PSP) which started trading on October 24, 2006. BGI has made a relatively small number of moves into the the alternative asset class space but, like (IAU) which came after (GLD), this new private equity related offering fails to be first to market.

Somehow I don’t see this as being a significant problem for BGI. Not because they’re big or because being the first to market doesn’t matter (I think it does). In my opinion, I doubt there will be much success for either ETF. The idea behind private equity investing is clear, and a couple of people named Sarbanes and Oxley ought to receive sizeable paychecks from the industry for putting a killer headlock on the publicly traded markets. More like a choke hold that has greatly helped the private equity market to explode, especially in the past couple of years. There has been so much discussion of institutional interest in private equity investing from funds like the Yale Endowment that I won’t dig too deep there.

But just because it’s good for large institutions doesn’t mean it’s appropriate for the smaller ordinary investor. I think this is equally true for hedge fund investing. As I’ve said in past postings, you can diversify (although it only helps you to a degree less than you might think), add hedging instruments (options, inverse ETFs, etc.) and other defensive measures such as simply reallocating with greater weights to cash. For many investors, especially smaller ones, hedge funds and private equity are unnecessary. It’s the bang for the buck that is missing, primarily due to high fees and especially when involving smaller investable amounts.

So larger individual investors may look at these new private equity ETFs, but would they or should they? I would probably lean more towards a fund-of-private equity funds … very similar in concept to a fund-of-hedge funds. Of course, there’s that added layer of fees, so the first question to ask is: Should I even bother getting into this area? This is the same question one would ask when entering any area such as emerging markets or inflation hedged bonds. But in these cases, as in most cases the question can be left to only one level: Do I invest in this area? For private equity, and in the context of this blog, the follow up question is more significant than the other examples given. The next question is: Is the ETF the way to go? This is a far tougher question when considering private equity versus US large caps or even emerging markets. In concept, I like the idea of a private equity ETF. But in terms of implementation, I’m thinking that there are more appropriate substitutes available.

What about institutions like hedge funds, who I have suggested on numerous occasions in the past are big users of ETFs? I would be more than surprised to think of them using these instruments. If they wanted to get into the private equity game, an ETF would be the wrong end for them to be looking at.

So who would be interested in this type of instrument? I suppose the same investor who buys fund-of-hedge funds. And how have they done over the past 5 years or so? Investors haven’t had the returns shown in the marketing material when they got in, I’m fairly sure of that. I would only think that returns in the private equity space can’t possibly be sustained at the level they’ve been over the past few years. As is commonly the case, the moment you actually put your money down to a specific manager, a particular asset class or strategy … well, it’s usually the time it fails to deliver. Not to be pessimistic, but for every seasoned investor, you must have experienced that situation at least once in your life. I’m guessing a lot of hedge fund investors have had to re-examine their expectations in recent years. Damn this bull market!

I will certainly follow these two private equity ETFs and the flow of funds into both. In terms of trading strategy, I’d like to see how shorting them would affect a broadly diversified alternative investment portfolio. You can’t be long hedge funds, private equity, commodities, real estate and other alternatives all the time … well you can, but each can have a VERY long period of decline or close to zero returns. Perhaps an opportunistic short overlay of one of these private equity ETFs along with a few others could fine tune the alpha capture of an alternative investment portfolio. Just a thought.

Oh, it was only a matter of time before another private equity ETF came out. Any bets on when an ETF with some sort of hedge fund strategy (investable hedge fund index, replication strategy, something else) might come out?