ETF Lets You Play in Private Equity

I'm not sure why I should care about investing in private equity, but I know it must be important because the financial media tells us it is.

So, to offer private equity to the masses, PowerShares issued the Listed Private Equity Portfolio (PSP). The fund will own more than 30 companies that are involved one way or another with private equity, corresponding to the Red Rocks Listed Private Equity Index.

I tend to give the benefit of the doubt to new ideas, but this one seems like a stretch. In all seriousness, people interested in this part of the market are looking for investments that garner high returns with a low correlation to the stock market.

I was recently quoted in another publication about this fund, and I opined that meshing together many companies that engage in private equity might result in a fund that is more correlated to the market than might be ideal. My thought here was that different private equity firms might specialize in different types of deals, both in terms of structure and market segments.

Turns out that may be spot on. According to literature I received via email that should be on the PowerShares Web site shortly, the Listed Private Equity ETF has a 0.70 correlation to the S&P 500. That doesn't seem like a low number, given that low correlation is a goal of the fund.

Apollo Investment (AINV) has a 0.56 correlation to the S&P 500, Allied Capital (ALD) has a 0.24 correlation, and KKR Financial (KFN) has a 0.36 correlation, all according to PortfolioScience.com. All three are in the new fund, do slightly different things in the world of private equity and have a much lower correlation to the broad market than the fund.

The point of buying an ETF is to capture a particular effect or sometimes multiple effects. It stands to reason that some ETFs will be a great way to isolate and capture some desired effect, but of course not every new product can be the best way to own a given slice of the market.

Taking a Closer Look

Before this article, I hadn't examined any of the listed "private equity" stocks. They offer some interesting secondary effects. They have low correlations to the market, as noted earlier, and very high yields: KKR Financial at 7.5%, Allied Capital at 8.0% and Apollo at 9.1%. I've written several articles about stocks with low correlation, high yields and low volatilities. These stocks offer two out of three, but the volatility is high. All three have standard deviations that are much higher than the S&P 500.

From here, I'm inclined to explore what utility there might be in the fund, even if the private equity aspect is less than ideal.

Source: PowerShares.com

As with every ETF, so it seems, the back-test of the index is compelling. The chart appears to show some correlation to the Russell 2000. The fund is actually heaviest in mid-cap value, 30.86%, so a comparison to that part of the market might have been more useful.

It also has a high yield. Although not on the information sheet at the PowerShares Web site, I called the company and was told that it yields 4.35%.

If there is utility with this fund, it would be as a tool to reduce cap size, increase volatility, have a lower correlation to the broad market and add some yield. On paper, this doesn't seem so bad, but you can decide for yourself if this will be the best possible way to do all those things for your portfolio.

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