Private Equity ETF

Private Equity ETF is a type of exchange-traded fund that only invests in companies that do not trade on the stock exchange and provides an opportunity for small investors to participate and gain from such exposure. Listed private equity ETFs are heavily transaction oriented and use leverage as most of these companies are complicated in financial terms.

Investors look to invest in such funds to gain exposure into a relatively less explored market and because of the attractive gains from such investments. These ETFs are listed on exchanges and investors can invest through their demat accounts into these funds. The two of the most popular names in this domain are PSP and PEX.

• A private equity ETF is an exchange-traded fund focused on non-publicly traded companies. This avenue allows smaller investors to participate and potentially profit from private equity investments, which are typically inaccessible to individual investors.
• Private equity investments are often characterized by long holding periods and limited liquidity. Contrastingly, investing in a private equity ETF offers investors the flexibility to buy and sell shares on an exchange, providing enhanced liquidity and catering to a broader investor base.
• Investing in a private equity ETF provides a unique advantage – it is traded on an exchange, offering increased transparency in exposure to the private equity sector. 

Private equity ETFs are a baset of companies that are not listed on the stock exchanges like public companies. These ETFs give investors an opportunity to gain exposure into a segment of the market that is relatively less explored.

As PE investment is supposed to be a long-term investment, it is illiquid; however, the investment in an ETF provides buying and selling flexibility and therefore generates flexibility and attracts a larger pool of investors.

Investment required to own a share in a privately held company is huge because these companies are in their growth phase; however, they don’t possess the professional management strength of a listed company. For the smooth running of the business, they seek investment from venture capitalists or angel investors, and so on. One such investor could be an investment management firm.

These firms, which are listed on the stock exchange, enter into such an investment because they have a longer investment horizon, lower immediate liquidity requirement, and diversification requirement. Therefore they hold huge chunks of PE investment.

At times these firms enter into the ETF format in which they subdivide their ownership into small units of shares, also known as creation units, for relatively smaller investors to participate. These shares are sold through the exchange and provide exposure to the PE domain.

Further, the benefit of investing in an ETF is that it is traded on the exchange and therefore brings greater transparency in PE exposure, which is otherwise not possible in the investment in this domain.

Let us understand the components of a private equity ETF list with the help of an examples. The details within this example will give us an in-detail idea about the concept and its intricacies.

PSP - Invesco Global Listed Private Equity ETF is one of the most popular ETFs in this domain. The ETF invests a minimum of 90% of its AUM in around 40 to 75 companies, which form part of the Red Rocks Global Listed Private Equity Index (Index).

Some important fund details are as follows:

• Cusip: 46137V589
• ISIN: US46137V5892
• Management Fee: 0.50%
• Total Expense Ratio: 1.80%
• Exchange: NYSE Arca
• Inception Date: 24^th October 2006

Allocation Details

Assets of the funds are mostly allocated in the Financial sector, approximating 70.79% as of 24^th December 2019 as per the information published on the Invesco website, and the remaining 30% is spread across close to 9 other sectors, of which the Industrial sector leads at 10.25%

Further, according to the country-wise allocation, on the same date, the US holds 39.70% of the total AUM, and the UK holds 18.09%

Based on the nature of the investment, as on 23^rd December 2019, the ETF had the following percentages:

#1 - Performance Overview

Compared to the underlying index, Red Rocks Global Listed Private Equity Index (Index), The ETF has been lagging behind in terms of the growth per $10000 as of 30^th September 2019, which is due to the variation in the securities composing the two. The fund's growth trajectory follows a similar pattern as that of the underlying index because most of its composition contains the same securities; however, the difference in asset allocation has not been favorable to the ETF.

In absolute terms, the value of $10000 became $27,606 for the underlying index and 24,212 for the ETF. Therefore we can say that the tracking error for this ETF is non-zero, and it has not been able to replicate the underlying index fully.

• The total number of outstanding shares in the fund is 16.35 million having a market value of $206.5 million as of 24^th December 2019
• ROE, as of 30^th September 2019, was 12.58% and was calculated by dividing the net income by net worth.
• The price to book ratio, which is calculated by dividing the market price by the book value, was 1.80 as of 30^th September 2019

#2 - Risk Overview

The risks involved in investing in this ETF are as follows:

• Some of the securities in the ETF are in the form of ADR and GDR; that is, the underlying investment is made in foreign companies and therefore is subject to currency risk and country risk.
• As the investment is made in the stocks of smaller companies, the returns get affected by the slowdown in their respective economy more brutally and quickly than the publicly listed companies' stock returns.
• Further, there is a lack of liquidity in such an investment.
• This fund is focused on the Financials sector and is less diversified. Therefore any small negative force in the sector has a greater impact on the returns.
• The lack of availability of public information doesn’t help the investors much as the investment is not an informed one.

It is clear from the discussions above that  a PE ETF is a way relatively smaller investors can get exposure to privately held companies to diversify their portfolios. Although this exposure is possible, investment in ETF can only be made in multiples of creation unit blocks, which is not very small. Therefore, we say such an investment is only 'relatively' small compared to a direct investment in the private equity domain.

It is a means for investment management firms to generate capital that they might invest in such companies with expectations of huge returns; however, the risk of such an investment is higher than investing in any other listed security.

This has been a guide to what is a Private Equity ETF. Here we explain an example with its performance & risk overview along with a detailed explanation. You can learn more about it from the following articles –

• Keogh Plan
• Leveraged ETF
• Bond ETF
• Mutual Funds vs ETFs