On September 23, the SEC lifted the general solicitation ban on advertising private offerings, a key portion of the Jumpstart Our Business Startups (JOBS) Act enacted earlier this year. This means that private equity firms can begin advertising their funds to the general public, a practice forbidden since the 1930’s.
Although your clients might think that they are in investing in the next Google or Facebook through a JOBS Act investment, advisors should educate their clients on more established methods to obtain exposure to private equity in a more liquid and fee-friendly fashion, such as listed private equity.
The following are the four main publicly available listed private equity structures. Advisors should familiarize themselves with these structures and understand how each can provide diverse, unique benefits for client portfolios.
1. Asset Managers
Investors may be most familiar with this listed private equity structure, which includes managers such as Kohlberg Kravis & Roberts (KKR), The Blackstone Group (BX), and Apollo Global Management (APO). These alternative asset managers provide exposure to private equity returns in two ways: directly, through co-investment in their own private equity funds, and indirectly, through carried interest earned on private company sales. Private equity manager stocks provide liquidity and brand name recognition, but they are one of the least direct ways to gain exposure to private equity in the listed private equity space. Their returns are based primarily on the overall ability to grow assets under management and generate fees, rather than the underlying private company returns.
2. Direct Investment Firms
Direct investment firms may be less familiar to investors in the United States, but they are a common structure for private equity firms in Europe and elsewhere. Direct investment firms raise a permanent pool of capital from investors, and invest this capital in a basket of privately held businesses. Then then grow these companies and exit them over time. The net asset value growth of these private holdings is the key driver of stock price movements, providing a much higher correlation to traditional private equity fund returns. Examples of direct private equity investment vehicles include Electra Private Equity (ELTA LN) and HGCapital Trust PLC (HGT LN).
Private equity fund-of-funds strategies are quite common, but most investors are unfamiliar with publicly traded versions of this structure. Quoted fund-of-funds structures including Harbourvest Global Private Equity (HVPE LN) and Pantheon International Participations (PIN LN) invest balance sheet capital as a limited partner in a diverse set of private equity funds. These structures can provide investors exposure to funds managed by well-known names such as TPG, Bain Capital and Hellman Friedman, which are otherwise unavailable to retail investors. The downside of this structure is the potential for fee layering, where fund-of-funds managers charge their own fees in addition to fees charged by underlying fund managers.
4. Business Development Companies
Although business development companies (BDC) are referred to as private equity vehicles, they rarely provide true private equity exposure for investors, as they are typically debt investors. They often do not have a controlling stake in their holdings, and therefore, have little influence on the strategic direction of their private investments. BDCs must pay out 90% of their gross income as dividends, and, being primarily a debt investment, their returns can be highly sensitive to interest rate.