Private equity is often seen as a tool reserved for only the wealthiest investors. But that's not entirely true. The Invesco Global Listed Private Equity ETF (NYSEARCA: PSP) indirectly accesses private equity and doesn't require being an accredited investor or a qualified purchaser. It gives exposure to a diverse set of publicly traded asset management companies.
These companies specialize in managing private market investment strategies, including private equity, private credit, private real estate, and venture capital. The fund contains some of the world’s most well-known companies in finance, including KKR (NYSE: KKR), Carlyle (NASDAQ: CG), and Partners Group (OTCMKTS: PGPHF).
It's time to dive in and learn a bit more about private equity as an asset class, its merits, and what PSP can bring to the table.
Breaking Down Private Equity as Simply as Possible
To understand private equity, it’s easiest to first understand what public equity truly means. Equity refers to the investor having ownership, or stock, in a company. Public means anyone can purchase that stock from a brokerage account. If someone is 18 years old, they can easily buy equity in any publicly traded company through a stock exchange.
A private equity investment also represents ownership in a company. However, that company is privately held, meaning not just anyone can buy it. If someone has a friend with a local restaurant, they can arrange to pay that friend a certain amount of money to receive a percentage share of the company's profits every year. That would be a very simple private equity investment, simply an investment in a private company.
Private Equity Funds: Creating Higher Returns Through Debt, Control, and Long-Term Thinking
On a larger scale, private equity funds raise billions of dollars to buy ownership in very large privately-held companies. They’ll often also take on high levels of debt to help fund the purchase. These firms can frequently access very low-interest-rate debt, helping to increase the return on their investments.
By acquiring more than 50% of the company, they can change how the firm operates to increase its value based on their analysis of the business and its market. Concentrated ownership decreases the number of parties that need to agree, allowing change to happen quickly. This ability to have extreme control over a firm is sometimes called the “control premium” and helps increase the return of private equity funds.
Increasing value at a privately held company is often considered easier because management can have a longer-term perspective. It is not constantly worried about how the stock price moves daily, as can be true for public companies. It doesn’t have to worry about meeting quarterly earnings expectations set by Wall Street analysts.
A bad earnings report can cause a company's value to drop dramatically in one day. This puts immense pressure on executives to meet short-term goals. However, this pressure can result in under-investing in long-term projects that would have created more value. This ability to have a long-term perspective is another way private equity funds create value.
I’ve mentioned several ways that private equity funds can theoretically uniquely create value compared to investments in public equity, but does this play out in practice? By and large, the answer is yes. A 30-year analysis of private equity funds found that their returns outperformed the S&P 500 Index by 2.3% to 3.4% a year after subtracting fees. This outperformance is attractive, which is why PSP is an interesting investment.
PSP Provides Access to Different Sources of Return and Expert Investment Management
PSP has not outperformed the S&P 500. In fact, over the past 10 years, the S&P’s return is over double that of PSP. The fund's performance depends on how well the companies in its stock portfolio perform. Those companies’ revenues are primarily based on the management and performance fees they receive from operating their private equity funds.
Because only some of the revenue comes from the performance fees of those funds that may have outperformed, the returns will not be as high as the funds themselves. However, access to the underlying sources of return in the private equity funds is still gained.
This provides some portfolio diversification and indirect access to the skills of some of the world's most skilled investors who manage these private equity funds.
