Private equity, long reserved for the wealthy, could soon be available to everyday investors through ETFs. But experts are raising concerns about whether this innovation is truly viable and beneficial.
When BlackRock announced its 3.2 billion dollar acquisition of the leading private markets data provider Preqin, it was more than just a move to boost its trading platform, Aladdin.
The real news was the ambition hinted at by BlackRock’s CFO, Martin Small: creating ETFs that directly expose investors to private equity. This idea sounds appealing to retail investors, but it raises many questions.
Andrew Beer, Managing Director at DBi and an expert in hedge fund replication, is skeptical about private equity ETFs. “Investors could end up with a product that could drop by 30 percent if the S&P falls by 20 percent,” Beer warns.
His concerns stem from the key differences between private equity and publicly traded assets. Private equity is attractive partly because these assets aren’t priced daily like public stocks, which hides their real volatility. If you put these assets into an ETF, you lose that advantage, Beer told Investment Officer.
Monika Calay, Director of Research at Morningstar, highlights the liquidity mismatch between daily-traded ETFs and the inherently illiquid nature of private equity investments. ‘Accurate real-time pricing, NAV calculation, and the creation/redemption process become extremely complex with private assets’, she said.
The Pure Play Distinction
BlackRock’s ambition goes beyond the existing private equity ETFs that are already on the market. Current private equity ETFs typically offer indirect exposure by holding a basket of publicly traded stocks of private equity firms. While they track the performance of these firms—and, by extension, their fee structures—they don’t provide direct access to the underlying private equity assets.
Some of these ETFs also target adjacent opportunities, such as initial public offerings (IPOs) and special-purpose acquisition vehicles (SPACs), but they haven’t consistently outperformed broader market indices.
The pure play private equity ETF that BlackRock envisions would be a significant departure, offering direct exposure to the asset class itself, rather than just the firms managing the assets.
Regulatory compliance and maintaining the transparency expected of ETFs add further complications. Calay believes that while the potential profits could drive innovation, any viable solution would likely require a significant reimagining of the ETF structure.
‘Current approaches, like targeting public companies related to private equity, are indirect. Synthetic exposure seems the only way they could achieve it, and I can’t imagine how NAV and redemptions would work’, she said.
Lessons from the Past
There is a parallel between the current push for private equity ETFs and the failed launch of hedge fund strategies in mutual funds a decade ago. ‘In the early 2010s, many asset managers attempted to “democratize” alternative investments by launching hedge fund strategies in mutual funds and UCITS vehicles’, Beer recalls.
‘These products were largely unsuccessful, with average returns of less than 2 percent per year after fees—an outcome that was quite embarrassing for the industry.’
The lesson here is clear: Just because a strategy works in one format doesn’t mean it will translate well into another. The complexities of private equity, combined with the liquidity demands of ETFs, create a scenario that is fraught with potential pitfalls.
On the flipside, the ETF industry has a history of overcoming daunting challenges. From integrating from collateralized loan obligations to leveraged single stock-products into the wrapper.