As public market valuations continue to look stretched, investors have increasingly turned toward private assets for diversification and better downside protection.
In 2017, private asset managers raised a record sum of $750 billion globally, according to consulting firm McKinsey’s Global Private Markets Review. Private equity funds promise alpha and consistency of returns, but many investors still balk at the space’s lack of access, its high-fee structures and its illiquidity.
What then to make of listed private equity (LPE), which offers investors indirect exposure to private equity while also providing daily liquidity and lower fees? Surely this is the best of both worlds?
Investors, it seems, have shunned such funds since the financial crisis – a period when private equity firms had to lower the value of their underlying investments, prompting LPE funds’ share prices to drop accordingly. But as mainstream investors look lovingly at private equity once more, is LPE due a comeback too?
Open to interpretation
Unlike public equities, LPE does not have a fixed definition. The asset class can include any publicly-traded private equity firm such as Blackstone and The Carlyle Group, or any vehicle that employs private equity investment strategies. But it can also encompass special acquisition companies and blank-check companies – shell firms set up to carry out mergers and acquisitions.
Funds such as the ALPS/Red Rocks Listed Private Equity fund and the Invesco Global Listed Private Equity ETF, which invest in private equity companies, can fall within the realm of LPE too. As do business development companies and individual investment managers.
Even passively managed index replication strategies such as the Leland Thomson Reuters Private Equity Index fund can be considered LPE.
Jeremy Held, director of research at ALPS Advisors, sees value in these LPE funds. Because they specialize in smaller private companies, often referred to as middle market or lower middle market, the funds’ holdings tend to have good growth prospects at attractive values, he explained.
‘Not only do these companies typically display robust growth characteristics, they also tend to transact at lower Ebitda [earnings before interest, taxes, depreciation and amortization] multiples than their larger private counterparts,’ he said. ‘Whereas multiples for both public companies and larger private companies have expanded meaningfully in recent years, prices for middle-market companies have remained much more reasonable.’
Held noted that LPE is still trading about 10% below its all-time high, which is in stark contrast to many asset classes that are currently at or near their peaks.
One reason why the asset class is trading below the highs seen elsewhere is that investors are simply not as aware of it, according to Andrew Lister, senior investment manager within Aberdeen Asset Management's alternatives division.
And for many who are aware of it, LPE funds are viewed with some suspicion, he added, because unlike regular equity strategies, LPE funds do not receive a net asset value every day. Instead, the funds have daily share prices and only publish portfolio valuation every few months.
‘You have to do some homework. You have to be a believer in spreadsheets, which is what we use to monitor the net asset value,’ Lister said. ‘We model the asset value, and that presents to us opportunities because not a lot of people are doing what we are doing in terms of modeling portfolio valuations on a daily basis.’
Jonathan Barbato, head of manager research at Geller Advisors, said he prefers to invest in highly regarded private equity secondary funds. Rising rates and high valuations at this late stage of the current economic cycle have led him to hold a favorable view of private equity overall, but he does not expect to invest in LPE in the near term.
‘We will remain open-minded, but we do not currently anticipate investing in LPE funds,’ Barbato said. ‘We believe that investors are rewarded for an illiquidity premium and we’re skeptical that these listed products will replicate the returns of private equity funds.’