The use case for listed private equity ETFs is once again under the microscope following a year of explosive growth in returns and assets under management (AUM).

According to data from ETFLogic, the $1.2bn iShares Listed Private Equity UCITS ETF (IPRV) has returned 66.3% over the past 12 months, with investors piling in $311m net new assets as a result.

Enjoying an even more prolific period of recovery trading has been the $394m Xtrackers LPX Private Equity Swap UCITS ETF (XLPE) which booked inflows of $94m alongside monumental returns of 94.4%.

Launching in 2007 and 2008, respectively, both ETFs have seen impressive and consistent performance over the past decade, with their net asset values (NAV) jumping between two-and-a-half and three times apiece between October 2011 and February last year.

As Morningstar data suggests, this is in keeping with the private equity sector as a whole, which has even outperformed the tech-based growth equity segment over the past five years.

This pace of growth has also sped up since peak COVID-19 volatility last March, with both ETFs’ NAVs almost tripling in the 19 months following.

This owes to the opportunistic backdrop created by the pandemic. Not only have more disruptive companies emerged to fill new gaps in the market but correspondingly, more private equity and venture capital firms gaining scale and seeking listings. 

Among these have been Bridgepoint which listed on the London Stock Exchange in July at a value of £2.9bn, and then Goldman Sachs’s Petershill Partners which listed with a £4bn valuation in September.

This bullishness in private equity has also remained strong as some broad, listed equities benchmarks faltered in recent months. In fact, Blackstone, the largest constituent of IPRV with a 7.8% weighting, boasted its distributable earnings more than doubled during Q3. 

Do listed private equity ETFs live up to the hype? 

However, there are some who are unconvinced by the noise surrounding private equity. One such person in Nicolas Rabener, founder and CEO of Factor Research, said the returns enjoyed by private equity can be explained by small-cap exposure.

In fact, comparing the performance of an index comprised of the smallest 30% of US companies with market caps over $500m to the Cambridge Associates US Private Equity index, Rabener said the two benchmarks had “almost identical returns” between 1988 and 2018.

Though not quite identical in performance to IPRV and XLPE, two small-cap ETFs, the $291m SPDR MSCI USA Small Cap Value Weighted UCITS ETF (ZPRV) and $125m SPDR MSCI Europe Small Cap Value Weighted UCITS ETF (ZPRX) have both enjoyed successful years.

While ZPRX returned 57.2% and brought in $77.7m new assets over the 12 months to 27 October, ZPRV increased by a considerable 74.5% while seeing inflows of $168.3m.

Admittedly, this does not completely undermine the impressive showing put on by our listed private equity ETFs, however, ZPRV and ZPRX both manage this with total expense ratios (TER) of 0.30, compared to the far loftier fees of 0.75% and 0.70% charged by IPRV and XLPE, respectively.

For that extra fee, private equity ETFs offer investors exposure to a benchmark of listed companies that actively choose private equity and venture capital opportunities.

For the ETF diehards, the methodologies of ZPRV and ZPRX will probably be more appealing, as they opt for a rules-based approach that captures small-cap companies meeting pre-set requirements for size and liquidity and then weight them based on sales, book value and earnings.

This is not to say listed private equity ETFs do not serve a purpose. Whereas private equity is usually an opaque industry based on private transactions by the wealthy, putting listed firms into an ETF wrapper democratises access to a traditionally cliquish sector.

Furthermore, the Kellogg School of Management (KSM) at Northwestern University found private equity firms manage recessions better than other asset classes, so for diversification or hedging purposes alone, perhaps they deserve some consideration.

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