Recently PowerShares announced that they would be launching 66 new ETF’s. While 65 of them appear to somewhat suspect in their usefulness, one has caught my attention. The one that has the potential (and at this point it is only potential) is the private equity ETF index.
The ETF will track an index created by Red Rocks Capital Partners and called the Red Rocks Listed Private Equity Index. The index will track roughly 30 stocks that are publicly listed private equity companies. These stocks will include business development companies, and other companies whose primary business is to invest in or lend to private companies.
Notes on Index Construction from the SEC Filing
1. For a stock to be considered for inclusion in the Listed Private Equity Index, it must have a majority of its assets invested or exposed to private companies or have as its stated intention to have a majority of its assets invested in or exposed to private companies. The underlying assets may be domestic or foreign.
2. The Listed Private Equity Index is composed of a diversified mix of listed private equity companies. The listed private equity companies that will comprise the Listed Private Equity Index will be selected based upon reputation, valuation metrics, management, financial data, historical performance and the need for diversification within the portfolio. Diversification for the Listed Private Equity Index is viewed from three different perspectives: a) stage of investment; b) capitalization structure (E.G., equity, debt, mezzanine); and c) industry focus.
3. Each listed private equity company must have market capitalization of at least $50 million and a closing price above $1.00 per share for the trailing six months if not currently in the Listed Private Equity Index.
4. The Listed Private Equity Index uses a modified equal dollar weighting. No single stock may exceed 10% of the Index weight at the time of rebalancing. The Index will be rebalanced quarterly.
One of the problems with private equity investing is that there is a huge amount of dispersion of returns. According to David Swensens book Pioneering Portfolio Management, the median return for private equity lagged both domestic and foreign equity (timeframe of 1980-1997)
Venture Capital
» 1st Quartile: 17.1
» Median: 8.1
Leveraged Buyouts
» 1st Quartile: 23.8
» Median: 13.2
Domestic Equity
» 1st Quartile: 16.6
» Median: 15.5
Foreign Equity
» 1st Quartile: 16.1
» Median: 14.9
While the median returns are less for private equity, the top quartile private equity far outperformed the first quartile equity managers. So what you get when you buy the index is something much closer to the median (or under it) than the top quartile. Another concern with using an ETF that tracks private equity stocks is that such an index will not track the true returns of private equity.
While one of the reasons to invest in private equity is for diversification (along with higher potential returns) within the portfolio, this ETF might not provide that benefit. It’s completely possible that this ETF will not track private equity returns like it designed. You might only be tracking 30 small/mid cap financial stocks. Since I don’t know what stocks will be included in the index it’s impossible to see if those stocks will correlate highly with private equity returns. My guess…they won’t. See when you invest in the equity of a private equity firm you are really investing in the financial structure and management talent of that company. That might not match up to the underling strategy that it is intended to.
For now I plan on taking a wait and see approach to this ETF, but it might find a way into my portfolio. A lot will depend on how it ends up being structured.
Other details:
Launch date- October, 2006
Expense ratio- 0.70%
Website- PowerShares