Last fall I wrote an article about the then-newly listed PowerShares Listed Private Equity Portfolio ( PSP) that tracks the Red Rocks Listed Private Equity Index.

I was generally skeptical about whether a fund with a bunch of different companies specializing in different types of deals could offer returns that capture a private-equity effect.

My concern was that the specialties of each of the holdings would be blended away, and the result would look a lot like the market.

Private equity was a hot area last fall and has become even hotter since as the pace of new deals seems to have accelerated, so I felt it would be worth revisiting this area to see whether my skepticism was well-founded.

Private Equity vs. the Market

As the first chart shows, PSP has clearly outperformed the S&P 500 and the Russell 2000, but I'm not sure that the incremental outperformance has been a bonanza of private-equity riches.

PSP is heaviest in mid-cap value stocks.

Using iShares Russell Mid-Cap Value Index Fund ( IWS) as a benchmark (second chart), you can see that PSP has lagged slightly since its inception.

(Please see charts below.)

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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) 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) 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) 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) 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), which is up 25% over that time. LUK is more of a conglomerate that some liken to Berkshire Hathaway ( BRKA) 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.
At the time of publication, Nusbaum and his clienters were long PowerShares Water Portfolio and his clients alone were long Bank of America, although positions may change at any time.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback; click here to send him an email.