Can ETFs Capture Private Equity Returns?
It is probably not practical to try and squeeze primary private equity funds, which are usually held for many years, into an ETF that offers intraday dealing.
An ETF could however hold listed equities in private equity managers, and iShares Listed Private Equity UCITS ETF (IPRV) does that. Its largest holdings are private equity firms listed in the US, Canada, UK, Switzerland and Sweden: Partners Group, Brookfield, Blackstone, 3I, KKR, Apollo, EQT, Ares, and ICG.
An alternative approach is to try and pick stocks that have the qualities typically sought by private equity managers.
A new ETF doing just this has been identified in the ULTUMUS ETF data library, which is updated daily and globally: KraneShares Man Buyout Beta Index ETF (BUYO). It tracks the Man Buyout Beta Index, which applies the factors behind private equity buyout funds to picking public equities. The index systematically selects small to mid-cap stocks from the Russell 2500 Index, to create a portfolio intended to be correlated with private equity buyout fund returns.
The selection criteria include a top-down sector bias to technology, healthcare, consumer discretionary and industrials.
Bottom up, companies need strong free cash flows, operating margins, cash discipline and revenue growth.
The index was created by Man Group, a UK-listed alternative asset manager, and has been running since 2018. Investors might want to try and dig out the index returns to see how it might have performed over the past 6 years.
The top ten holdings currently include Dutch/US software group Elastic, German medical testing group Qiagen, global media group News Corp, and US telehealth group Teladoc. Note that the “small and mid cap” description is in a US context; some of these firms such as News Corp, with a $15 billion market cap, would be “large caps” in European or Asian markets.
The expense ratio of 0.89% is relatively high, though iShares’ IPRV charges 0.75%.
Nonetheless, if Man Group’s quants have cracked the code for reverse engineering private equity returns, the fees are much lower than a typical private equity fund charging 2% management fees, and 20% performance fees above a certain threshold return.
The human element of expert private equity managers getting actively involved in managing and improving companies is missing, but time will tell if this formula-based approach captures the magic of private equity.
