Now, retail investors can get a P-E buzz – without the hangover

Private-equity firms marketing retail-oriented funds that don't require decade-long lockup

Jun 26, 2013 @ 3:45 pm

By Jeff Benjamin

There's nothing like a little market volatility to remind investors about the virtues of diversifying into alternative strategies.

With that in mind, the current market environment could represent an entry point to the private-equity space, which recently has become enamored with the financial advisory channel.

Nadia Papagiannis, director of alternative fund research at Morningstar Inc., has studied the various efforts by the private- equity market to create products specifically geared toward investors working with financial advisers. In a recent report, she identified a handful of brand-name private-equity firms that are fashioning registered retail-oriented P-E funds.

Ms. Papagiannis pointed out that private-equity firms Carlyle Group (CG), KKR & Co. (KKR), Apollo Global Management (APO), and Blackstone Group (BX) all have recently filed or launched retail-oriented P-E products. These firms are following the lead of Red Rocks Capital Group, which has a five-year-old mutual fund, ALPS/Red Rocks Listed Private Equity Fund (LPEIX).

According to Ms. Papagiannis, the $224 million Red Rocks fund “offers perhaps the most sensible way for retail investors to gain access to private equity while maintaining liquidity.”

In the private-equity space, where direct investments can come with mandatory lockups of up to 10 years, liquidity can be a strong selling point. Add the fact that minimum investments into registered funds starting at $2,500, and it can start to make a lot of sense for investors looking for a new level of diversification.

But there is a double-edged sword with regard to liquidity, according to Mark Sunderhuse, managing director at Red Rocks, which manages nearly $1 billion in the same style as the mutual fund.

“The only reason alternatives have ever worked for anyone is because they stuck with it,” he said. “Investors should stick with a private-equity investment for five to 10 years, but that's difficult because there's a human element involved.”

Mr. Sunderhuse admits it is a bit of a contradiction to offer investors liquidity and then suggest that investors should stay invested for a decade, but he realizes liquidity is a necessity to operate in the retail space.

That said, he still believes the private-equity model works best when the portfolio managers have the time to benefit from a full private-equity cycle, which includes buying a company, often by applying leverage, and then restructuring it for an eventual sale or other liquidity event such as a public stock offering.

Technically, most mutual funds shouldn't demand the same level of long-term commitment as a pure limited partnership P-E fund because most mutual funds are not making the same kinds of investments in individual companies.

The Red Rocks fund, for example, divides the portfolio into three broad buckets, including publicly traded private-equity funds, funds of funds and management companies that oversee third-party capital invested in private equity.

As Ms. Papagiannis pointed out, putting registered-product wrappers around the private-equity space is like most retail-class alternative strategies in that they aren't identical products. But they are close enough to give retail investors many of the benefits of alternative investing.

The Red Rocks fund is up 12.2% from the start of the year, which compares to a 6.8% gain for the MSCI World Index.

In addition to the liquidity that investors are discouraged from accessing, the retail products also come with another big advantage over their private portfolio counterparts: Reasonable management fees.

The Red Rocks fund has an expense ratio of 1.25%. By comparison, most limited partnerships charge a management fee of at least 1% in addition to a standard 20% performance fee.

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