Making Strides: The Push to Democratize Private Equity

Much of the recent developments have been centered around the $2 trillion private credit markets, which are much easier to value and more developed on a global scale. BondBloxx and Virtus just dropped the first pair of private credit CLO ETFs late last year. State Street Global Advisors and Apollo’s private credit ETF filing is still waiting in the wings. Meanwhile, the global private equity market, which is roughly three times larger, has proven much tougher to value and even tougher to trade. The PE market is bumping against the $6 trillion mark. However, more than $1 trillion of that cash has yet to be deployed.

On last week’s VettaFi webcast, we polled our live advisor audience to gauge their attitudes toward PE. Nearly 60% said they were either already invested in traditional PE on behalf of their clients or were interested in doing so. To some extent, PE serves as a safehaven play – being far less volatile and subject to dramatic repricing than the public market. But the allure has long been tempered by high barriers to entry, including steep capital requirements, regulatory hurdles, lock-up periods and illiquidity.

Private equity ETFs aim to bridge the gap between private equity’s exclusivity and the accessibility of public market investment tools. Up until recently, most PE ETF offerings have invested directly in PE firms themselves, rather than their underlying assets. Invesco offers one such product – the Invesco Global Listed Private Equity ETF (PSP B) – whose 66 holdings include KKR, Blackstone and the Carlyle Group. ProShares takes a slightly more focused approach with the ProShares Global Listed Private Equity ETF (PEX C+), which has about half as many holdings. Both funds invest in publicly traded PE firms, business development companies (BDCs) and other entities tied to private markets.

The problem is, performance is tethered to the stock prices of PE firms, leaving them far more susceptible to market sentiment and macro news. The limited universe of listed PE firms also forces ETFs to hold concentrated positions. For instance, PSP’s top 10 holdings constitute ~47% of its portfolio, while PEX’s top 10 holdings constitute ~67%. Such firms often have other investments beyond buyouts, making them imperfect conduits to the world of PE.

A handful of new ETFs have cropped up that aim to offer private equity-like returns. The KraneShares Man Buyout Beta Index ETF (BUYO), launched in October. The fund aims to achieve private equity-like returns by peering under the hood and providing exposure to publicly traded companies that share similar characteristics to those of typical buyout targets or private equity holdings. BUYO targets small-to-mid-cap companies included in the Russell 2500 Index. According to KraneShares, there is a 75% correlation between the total returns of the Russell 2500 Index and PE (as measured by the Preqin Private Equity ex-Venture Capital Index).

Charging just 0.89%, BUYO is much cheaper than traditional PE fees. The fund invests in a subset of the universe of companies whose profit and loss statements mirror private equity returns in the long run. Top holdings include Teladoc, NewsCorp, Nutanix and AI search platform Elastic.

Along with smaller investors who have no exposure to PE, those who already have regular access to traditional PE may still want to consider this fund to help fill in the small- and mid-sized gaps and more fully round out their exposure. Major endowments typically allocate around 20-40% of their portfolios to private equity, with some Ivy League Universities reaching as high as 36.7% of their total investment.

Kevin Orr, Head of Strategic Partnerships at KraneShares, told me many home offices have significantly upped their exposure to alternatives, such as private equity, lately.

“You’ve gone from the major wirehouses to other significant platforms that have gone from single-digit recommendations and alts to hardy double-digit recommendations. So high single, low double if you want to see this as a proxy for the private equity positions of traditional portfolios. It runs the gamut. Low double digits is what we typically see among the typical FA out there.”

Moreover, PE risk-return profiles exhibit a wide range of dispersion. But John Lidington, Co-Portfolio Manager of Liquid Private Alternative at Man Group, said the goal behind this ETF is to reflect PE’s longer-term performance.

“I’d say the expectation is still the multiple percentage points of outperformance versus the broader public market that you would expect from traditional PE. Realistically, you’re going to have that top-tier PE performance. We’re not necessarily trying to replicate that. There is going to be true alpha there. But I think as a beta we’re matching traditional PE returns."

Orr said overall, the ETF acts as a good proxy for the buyout portions of private equity-like funds. “You’re getting liquid proxy exposure, beta, to private equity-like returns in an efficient way, cost-effective way.”

Over the last few weeks, we’ve seen two new PE ETF launches — the Pacer PE/VC ETF (PEVC), which takes a systematic rules-based approach, and the AlphaQuest Thematic PE ETF (LQPE), which uses an actively managed derivative-enhanced strategy to emulate “investment themes” of traditional PE funds.

Private equity ETFs fill a niche for liquidity-conscious investors and those who have limited access, but their success hinges on addressing transparency, education, and market structure issues. As innovation continues, the ETF structure may evolve to better mirror PE’s intrinsic value. For now, they remain a compromise — a bridge between public markets and private equity’s exclusive party, fraught with challenges but brimming with potential for those who navigate their complexities wisely.

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