Investing in private equity can be like diving for pearls: incredibly rewarding, as long as you don't mind exhausting work and large amounts of risk. But a handful of mutual funds can give you exposure to the private equity market without as much work and with a few less risks.
Private equity partnerships can do extremely well over time. As with most partnerships, however, they feature high fees, long lockup periods and, many times, K1 tax forms as well, which are certain to endear you to your clients. Listed private equity funds, such as Blackstone (BX) and Ares Capital (ARCC), invest in the stock of private equity firms. The funds are highly liquid, cheap (relative to private equity partnerships) and K1-free.
In addition, you can get far more information from a mutual fund or exchange-traded fund than you can from a typical private equity partnership. "With funds, you get exposure to the private equity asset class with lots of sunshine," said Larry Solomon, director of investments and financial planning at OptiFour Integrated Wealth Management. "In most private equity investments, you get no sunshine."
Currently, there are two open-ended listed private equity mutual funds: ALPS/Red Rocks Listed Private Equity Fund (LPEFX), up 6.1% this year, and Leland Thomson Reuters Private Equity Index Fund (LDPAX), up 6.6%, according to Morningstar Inc. The ETF offering, PowerShares Global Listed Private Equity Portfolio (PSP), has gained 5.6% this year.
The ALPS/Red Rocks offering is actively managed by Red Rocks Capital. The PowerShares fund is an index fund which uses an index created by Red Rocks Capital. The Leland fund tracks the Thomson Reuters Private Equity Buyout Index.
To some extent, listed private equity funds bear strong similarities to small-company value funds, particularly if you add leverage, said Tim Courtney, chief investment officer of Exencial Wealth Advisors. "Rather than buy a handful of private equity companies, we'd rather buy small value," he said.
But listed private equity funds can be a good source of diversification, Mr. Solomon said. The ALPS/Red Rocks fund, for example has a 0.03 correlation with the Standard & Poor's 500 stock index and a -0.06 correlation to the Russell 2000 small-company stock index. In addition, both the ALPS/Red Rocks fund and the PowerShares ETF are internationally diversified.
Risks? Plenty. While the funds don't use leverage, the companies they invest in certainly do. In 2008, for example, the ALPS/Red Rocks fund tumbled 62.9%. In 2009, the fund soared 40.8%. "In the world of liquid alts, this is definitely not vanilla," Mr. Solomon said. "It's more like rocky road."
Mr. Solomon doesn't invest more than 3% of a client's portfolio in any one liquid alt, and that rule applies to listed private equity funds as well. And, because the funds are liquid, "If something goes wrong, you can get out quickly and easily."