ETF investors can tap into the private-equity space by looking to an ETF strategy that attempts to replicate the long-term return characteristics of diversified private equity allocations.
On the recent webcast (available On Demand for CE Credit), Accessing Private Equity-Like Returns on a Budget, Erik Stafford, John A. Paulson Professor of Business Administration at Harvard Business School, explained that investors have typically honed in on private equity because the investment strategy’s returns have been high relative to public market benchmarks with low drawdowns.
Specifically, private equity funds try to improve operations; advise, monitor and incentivize management; allow management to focus on long-term value; and secure preferred access to financing. These private equity strategies also exhibit several passive components, including the ability to buy firms with specific characteristics, hold positions for long periods, double the leverage and conservatively mark a portfolio.
As part of the selection process, Professor Stafford explained that financial buyers typically select components based on reliable predictors, such as small firm size, low EBITDA multiples, negative net share issuance and low profit margins conditional on positive profits.
Professor Stafford’s proprietary PE Replicating Index reveals that publicly traded equities with characteristics similar to those selected for leveraged buyouts have historically exhibited high risk-adjusted returns after controlling for common factors associated with value stocks.
Alternatively, hold-to-maturity accounting of net asset value, combined with multi-year holding periods, eliminates the majority of measured risk.