Most financials have been under the microscope in recent weeks, with poor reports coming out of both Bank of America and Citigroup and Washington pushing through a plan to overhaul the existing regulatory system. These events have caused many investors to wonder about the prospects of growth at big Wall Street banks; some are now looking to other corners of the market in order to provide exposure to financials without considerable downside risk. Private equity has seen growing interest from the investment community, and as a result is now facing a problem that most would love to have: the industry simply has too much cash. In the height of the housing market boom in late 2007 and early 2008, private equity firms were storming ahead, accumulating assets and making plenty of deals. But after the crash deals dried up and the number of investment options were severely limited as valuations fell and the ability of firms to conduct leveraged buyouts was significantly curtailed. That didn’t necessarily stop the cash from coming in, leading to an interesting dilemma; private equity firms now have too much money and not enough quality places to put the cash [see Three Country ETFs Likely To Survive And Prosper During A Double-Dip].
By some estimates, private equity firms are sitting on close to $500 billion in cash, but there is a shortage of appealing investment opportunities thanks to the rally in equity markets over the last 18 months. This leaves companies with two options; return the excess cash or find new projects. So firms are “feeling a lot of pressure to put the money to work,” said William R. Atwood, head of the Illinois State Board of Investment, hoping that private equity won’t start stretching too far for deals. “There is a big counterpressure — a requirement for prudence and returns from their investments.”
These trends present a unique hurdle to private equity firms, as a greater number of potential investors are competing for a smaller number of quality investment destinations. Neither the option to pay back the invested capital (and the management fees on the money) or invest in lower quality projects is particularly appealing. Either scenario does not look to have a happy ending for industry, putting these firms in focus for the second half of the year since most are legally required to invest all of the money within the first three to five years of the funds’ life or pay it back to investors. This looks to be especially key in the coming months as we reach the four year anniversary of one of the highest points in private equity inflow history, leaving little time for private equity to find new deals to satisfy investors [see Ten ETF Ideas For 2010].
Way To Play
For investors without the capital to buy into a PE fund directly, the PowerShares Listed Private Equity Fund (PSP) presents an interesting option. The fund tracks the Global Listed Private Equity Index, a benchmark that includes between 40 and 60 publicly listed private equity companies, including business development companies and other financial institutions or vehicles whose principal business is to invest in and lend capital to privately held companies.
Because each of these component holdings has interests in dozens (if not hundreds) of additional companies, the effective exposure offered by PSP is significantly more broad in terms of both underlying holdings and industries covered. PSP’s exposure is light on U.S. companies; roughly one-third of assets are in domestic private equity firms, with France (9.6%), Sweden (8.7%) and the UK (7.3%) receiving the largest non-U.S. weightings. So far in 2010, the fund is down close to 5%, including a big hit over the past three months [also see Will Buyers' Market Boost Private Equity ETF?].
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Disclosure: No positions at time of writing.