The first to take advantage of a market niche are big institutional investors. Retail investors are only invited to the party when they finally lose interest in it.
The massive mutual fund company Vanguard Group recently revealed plans to increase access to private equity for individual investors. At the same time, the manager of one of the biggest sovereign-wealth funds in the world was claiming that private equity was a problematic investment.
In the world of investments, these two images are all too typical: Big institutional investors are the first to take advantage of a market niche. Retail investors are only invited to the party when they finally lose interest in it.
I’ve already written about this trend in relation to alternative assets like real estate and hedge funds. This story was aptly encapsulated by William Bernstein of EfficientFrontier.com, who stated that the initial investors who arrived at “the alternatives banquet table… loaded up on lobster tails and prime rib and those who followed… got the tuna noodle casserole.”
Despite the overvaluation of the stock market and the turbulence in the bond market, many investors are keen to participate in private equity and other alternative assets. It is clear that Vanguard and its partner companies are merely meeting that demand, but investors and their financial advisors should be aware that they are likely to follow in the footsteps of other latecomers.
The exchange-traded fund market offered some of the earliest chances for individual investors to get involved in the private equity market. The chart above shows that over any trailing 1-, 3-, 5-, or 10-year period, neither of the two most well-known ETFs with a focus on private equity—Invesco Global Listed Private Equity PSP and ProShares Global Listed Private Equity PEX—has outperformed the broad-based Vanguard Total World Stock ETF VT.
Since there is a great deal of disagreement among academics over the most accurate way to calculate private-equity performance, the returns of these ETFs are by no means the last word on private-equity investing. Long-term, risk-adjusted, the typical PE fund has outperformed the public markets, according to some academics. However, it is safe to conclude that there is no simple or guaranteed way for ordinary investors to make market-beating gains in the PE space, given the chart and the scholarly debate.
Sheikh Saoud Salem Abdulaziz Al-Sabah, managing director of the $1 trillion sovereign-wealth fund Kuwait Investment Authority, said the current state of PE is very grave. “We’ve been seeing private-equity funds grow up in size with the same number of portfolio companies,” Al-Sabah stated in a May speech at the Qatar Economic Forum. They are projected to be 10, 15, and 20 billion dollars in size. You must be realizing assets worth $40 billion if the base case of underwriting is twice your return. Who will purchase them is the question.
Al-Sabah responded to his own query by saying, “I’m not sure. The fact that they are nearing the conclusion of their financial life cycle is the worst part of it.
Not much has been revealed about Vanguard’s private-equity offering, except from the fact that it will entail a collaboration with money managers Blackstone and Wellington Management. “Solution details are expected to be announced in the coming months,” according to a press release issued in April to announce the partnership. The three investment firms “will collaborate on developing simplified multiasset investment solutions that seamlessly integrate public and private markets as well as active and index strategies” that institutions would otherwise be the only ones able to access.
Pay special attention to the management fees Vanguard will demand if, in spite of the warning indications, you are still interested in its potential private-equity offering. Since it’s likely to be a fund of funds, layers of fees are to be expected; these costs have the potential to consume most or all of the returns from private equity.
