Private Equity Isn't Just For The 1%

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Includes: APO, BX, BXMMX, KKR, LPEAX, LPEFX, PEX, PSP
by: Wall Street Daily

By Shelley Goldberg

Last week, I addressed the advantages of investing in private equity (NYSE:PE). Hopefully I piqued your interest. But perhaps you shied away in the belief that your net worth would prohibit you from investing.

If the latter is the case, don't fret. There is a way in. The key is publicly traded private equity. You don't need to be affluent to invest. And you don't have to be a qualified purchaser.

You might be thinking that publicly traded private equity sounds like an oxymoron. But PE is no longer considered an exclusive domain of the uber-wealthy. These days, it can be an investment vehicle of choice for all investors.

Getting in the Game

There are approximately 200 public companies around the world that invest in private equity. There's also a growing number of U.S. mutual funds and exchange-traded funds (ETFs) that do, too. For the retail sector, you can choose between listed private equity ETFs and private equity mutual funds.

For ETFs, check out the PowerShares Listed Private Equity Portfolio ETF (NYSEARCA:PSP) and the ProShares Global Listed Private Equity ETF (BATS:PEX). These ETFs are typically indexed to track the performance of an underlying fund. Some examples of mutual funds are the ALPS Red Rocks Listed Private Equity Fund (MUTF:LPEFX) and the Vista Listed Private Equity Plus Fund (MUTF:LPEAX).

What to Look For

So how should you compare and contrast these investment vehicles beyond just their returns?

First, look to see if the fund is a pure-play PE fund. Under normal circumstances, some, such as Vista, put at least 80% of their total assets in private equity. You really don't need to have a fund devoted 100% to the sector, as this gives the manager flexibility in the event that there's a lack of opportunity in the PE space at any given time.

Next is the expense ratio, which is the annual fee that all funds or ETFs charge their shareholders. PSP, for example, shows a net 2.05% ratio. Then look at the total number of holdings (LPX currently has 30), as well as the top 10 holdings, which will provide a window to the portfolio's diversification. From there, look at the breakdown by sectors and industry. LPEFX, for example, is heavily weighted in financials.

The portfolio can be further diversified by geography (developed and emerging markets) as well as the stage of investment and capital structure. PEX currently has 47% of its investments outside the United States. Diversification is typically a good thing, as long as the portfolio managers have the in-house expertise to invest in these market segments. And if you're looking for income, focus on the dividend yield, which is typically defined as the SEC 30-day yield. PSP currently yields 3.06%.

Investors should also look at the amount of holdings in business development companies (BDCs). BDCs aren't private equity per se, but they invest in the debt of private companies and pay shareholders the income generated. ALPS, for example, largely avoids BDCs, while Vista's fund has been known to carry a greater weighting in them.

Other characteristics investors should pay attention to include:

  • Whether funds are closed-end funds, which means they aren't typically redeemable upon request, have a higher minimum requirement, and have a set number of shares for purchase.
  • The amount of leverage in the fund. In a low-interest-rate environment, leverage can be a positive. Conversely, rising interest rates can create greater risk and volatility.
  • The level of risk in the portfolio, using such metrics as alpha, beta, standard deviation, and Sharpe ratio over time. These are translated into the excess return over the market, the correlation to the overall market, the volatility of the portfolio, and a measure for calculating the risk-adjusted return. Generally speaking, the greater the value of the Sharpe ratio, the more attractive the risk-adjusted return.

Some managers invest in other PE managers. Vista lists its top two positions as Blackstone Group L.P. (NYSE:BX) and KKR & Co. L.P. (NYSE:KKR), which adds a layer of complexity to the portfolio, as you'll then need to assess those managers as well. Fund managers holding positions in other manager generally don't pass on those added fees to their investors, and will list a fee waiver or reimbursement in their fee structures. These fees aren't direct costs paid by shareholders, nor are they used to calculate net asset value.

Beyond Indices

Managers investing in other managers leads to my next point: You don't even need to invest in ETFs or mutual funds to get access to the big PE firms. You can now invest in some of the PE partnerships that trade publicly, such as KKR or Apollo Global Management, LLC (NYSE:APO) and Blackstone Group. Not only did these firms decide to go public, but they've been rethinking their business models by launching their own mutual funds, such as the Blackstone Alternative Multi-Manager Fund (MUTF:BXMMX).

Private equity can offer many advantages over publicly listed stocks. And the nice part is that many PE investments are less subject to market noise and correlated to large macro moves. After all, not every investment has exposure to China. Still, be advised that even publicly listed PE has its risks.

Even with daily liquidity, a fund's money can be locked up for several years. Distributions may be made only as investments are converted to cash, with limited partners having no right to demand that sales be made. As an example, the private equity giant KKR was forced to close its two mutual funds last year after launching them less than two years prior largely due to a liquidity mismatch.

Liquidity can have its disadvantages, too. Because they're publicly traded, shares of a private equity company sometimes perform differently from those in the underlying portfolio of private businesses. Overall, adding a bit of PE to your portfolio can add diversification and good potential returns if you have the patience to wait it out.

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