This column has devoted significant space to the “publicization” of private equity, whereby Joe Investor gains direct access to an asset class that previously had treated him like a female applicant for membership at Augusta National. Examples include business development companies (BDCs), special purpose acquisition vehicles (SPACs) and the listed Apollo and KKR funds in Europe.
My gut response to this trend has been positive – gatekeepers can seem so Old Boy’s Club – although I am concerned that these vehicles are not generally structured to provide the same ROI potential as would a traditional GP-LP arrangement. Baby steps, I guess.
The latest such progression will come next week from PowerShares, in the form of an exchange-listed fund (ETF) focused on companies whose “principal business is to invest in – and lend capital to – privately-held companies.” For the uninitiated, ETFs initially issue their shares in large blocks called “creation units,” after which they often are broken up and traded on the secondary market. They also are known for trading at significant discounts to portfolio valuation.
The PowerShares vehicle will trade on the AMEX, and is based on an index formulated by Red Rocks Capital of Golden, Colorado. It currently contains 34 companies (each with different weighting), including: Usual suspects like Apollo Investments (4%), American Capital Strategies (8%) and Macquarie Infrastructure (5.5%); slightly further reaches like Silicon Valley Bank (7.5%) and CIT Group (6%); and some bubble nostalgia companies like CMGI (3%).
I spoke last week with the Red Rocks guys, who believe that this vehicle could transform the private equity securities market like REITs transformed the real estate securities market. The primary buyers are expected to be defined contribution plans, but expectations also are that the individual investor interest will be stirred up by the current PE market hype. I asked if the index would ever include foreign securities – Onex, the Apollo & KKR Euronext funds, 3i, etc. – but Red Rocks declined to comment on any future additions.
This fund already has taken some press barbs from those who believe that it is a byproduct of the aforementioned hype. Some analysts also have warned that investors might not understand the illiquid nature of the index’s underlying portfolio companies (even though the ETF shares, of course, would be tradable).
The first point is fair, and I’d hope that prospective buyers understand that they aren’t getting into the new Carlyle fund. Valuation fluctuations will be less dramatic – both up and down – than in a traditional fund, and even outstanding performance will not approximate the latest Blackstone Group or Sequoia Capital fund. Instead, it could be a useful tool for diversification – just as REITs have been (since they also have some underlying liquidity issues). It is admittedly a double-blind pool – like a traditional fund-of-funds — but at least the initial top-layer portfolio can provide some performance guidance.
It is impossible to predict which will be proven correct: My optimism or critic pessimism. But one thing is for sure: Copycats will come quickly, just as they have after past private equity “publicization” innovations. And just as before, most of the followers will fade away just as fast.