Buyout Bust? Steer Clear of Private-Equity ETF

Compelling Components

Many of the companies in the Private Equity ETF offer the compelling qualities of a low correlation to the broad market and high dividend yields. While these stocks tend to be volatile, the correlation and yield make these stocks, individually, worthy of consideration when purchased in moderation. American Capital Strategies (ACAS Quote) has an 8.63% weight in the fund, yields 7.7% and has a 0.55 correlation to the S&P 500. Allied Capital (ALD Quote) has a 6.63% weight in the fund, yields 8.4% and has a 0.23 correlation to the S&P 500. One last one: CapitalSource (CSE Quote) has a 6.60 weight in the fund, a 9.1% yield and a 0.53 correlation to the S&P 500.

Because of the nature of funds, the yield goes down and the correlation goes up, potentially muting the effect sought from this subsector. PSP has 0.85 correlation to the S&P 500 and yields 2%. (PSP has paid two dividends so far. I get 2% by annualizing those two dividends so the actual number could be higher or lower.)

The extent to which PSP might actually capture private equity is, I believe, muted. One possible use might lie in the fact that the fund is 70% in the financial sector, but unlike every other financial sector ETF, PSP is not dominated by mega-caps such as Citigroup and Bank of America. So, PSP offers a way into the smaller end of the financial sector without having to select a stock.

It is difficult to capture too many sectors with anything other than a large-cap product. There are a couple of other theme ETFs that, as a secondary effect, offer smaller-cap exposure to a specific sector. The PowerShares Water Portfolio (PHO Quote) is an example of smaller-cap exposure to the industrial sector.

Anyone looking to more directly participate in private equity may be better off studying the components of PSP. The names held in the fund mentioned above have all lagged the fund over the last six months, but the yields are very high.

A big winner for the fund has been Leucadia National (LUK Quote), which is up 25% over that time. LUK is more of a conglomerate that some liken to Berkshire Hathaway (BRKA Quote) and has a long track record of market-beating returns.

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Is It Worth It?

So does investing in this space via any exchange-traded vehicle make sense?

The last few months have been a heyday for the private-equity industry, but most of the larger holdings in PSP have started to roll over in the last six months. The combined weak performance of some of the better-known stocks held in the fund and all of the deal flow that is happening creates a disconnect that leads me to think that the group is probably best left to others. If you think I am missing something, I might be -- which is all the more reason for me to stay away.

The one stock I looked at that is doing well, Leucadia National, seems like a standout worth learning more about.