When it debuted in late October, the PowerShares Listed Private Equity Portfolio ( PSP) generated a lot of excitement. That's because it was the first exchange-traded fund to give investors exposure to stocks whose main business is to invest in or lend money to privately held companies. Everyone seems to have a strong opinion as to whether this is a good idea. So when one of the ETF's holdings, Utek plummeted almost 40% on Oct. 26, just days after the ETF launched, industry observers took note. But it wasn't because the stock's decline had a big impact on the ETF. In fact, Utek accounted for only about 0.75% of PSP's portfolio at the time, and the ETF managed to close higher that day. It was a bit of wake-up call though, reminding investors that they need to check what securities underpin an ETF before plunging in. Many say this is particularly true with the private-equity ETF, as there are some other questionable holdings and the ETF may not be exactly what it claims to be. "Any ETF has the risk of having one of its components blow up like that," says J.D. Steinhilber, founder of AgileInvesting.com, an investment advisory subscription service that provides advice on managing portfolios with ETFs. However, he says the private-equity ETF, which has just 34 holdings, is more concentrated than most. That makes it more susceptible to a big decline in an individual stock.
Additionally, Steinhilber says that because many of the companies held in the ETF are small and are micro-caps such as Capital Southwest ( CSWC - Get Report), Gladstone Capital ( GLAD - Get Report), Investment Capital ( TICC) and Hercules Technology Growth Capital ( HTGC - Get Report), coupled with the general risks involved with private equity, "this security will be more volatile and have a higher risk profile than
other ETFs," he said. "Anyone buying it should have that in mind and have an appropriate time horizon." Greg Newton, a freelance financial journalist who runs the Naked Shorts blog agrees: There are some "pretty questionable companies" held in the ETF, he says. "People have to be a lot more careful about taking a look under the hood." Other observers also have expressed concern that the private-equity ETF may not be exactly what it claims to be. "Part of the problem is a lot of the companies in this ETF basket aren't really private equity," says Carl Delfeld, president of ChartwellETFAdvisor.com, an ETF portfolio advisory service. A lot of them instead "lend money or do leveraged buyouts or service private-equity companies," he says. "So it's kind of an awkward fit." There are companies in there that are more lenders than private equity companies in the sense of buyouts and venture capital, says AgileInvesting.com's Steinhilber. "The name is a bit misleading." Some of the companies Steinhilber points to include Allied Capital ( ALD), which accounts for about 6.5% of the portfolio, American Capital Strategies ( ACAS), which makes up about 8.5% of the portfolio, and Capital Source ( CSE), which is 7% of the holdings. Those stocks are "very different from a lot of the other companies in the portfolio like early-stage pharmaceutical companies and owners of mutual fund companies," he says. "It's a real mixed bag, so I think investors really need to examine" what the ETF really is.