New ETFs Attempt to Mimic the Portfolios of Private Equity

Updated on
  • USCF readies two funds that look to buy ‘cheap’ companies
  • Methodology is based on Harvard economist’s 51-page paper

What Makes an ETF Attractive to Investors

ETFs aren’t always the simple index funds people think they are. 

Sometimes they behave like hedge funds. Now a Northern California investment manager wants to turn them into private equity portfolios.

USCF Advisers LLC of Oakland, California is readying two exchange-traded funds that use a theory devised by a Harvard professor in an attempt to mimic the outsized returns typically reserved for private equity investors, according to a filing.

The USCF SummerHaven SHPEI Index ETF, which will go by the symbol BUY, and the USCF SummerHaven SHPEN Index fund, ticker BUYN, will pick companies that trade “cheaply” relative to the market, making them likely targets for private equity takeovers. BUY will equal weight U.S. companies with market capitalizations between $100 million and $10 billion, while BUYN will invest exclusively in natural resources firms.

At 95 basis points a year, they’re a bargain compared with what Apollo Global Management LLC or Blackstone Group LP charge. The question is whether these funds will be able to replicate the complex work those firms do in selecting their investments.

“It’s definitely tempting to try and democratize every single frontier that’s under the sun, but this is a bit of a stretch,” said Eric Balchunas, a Bloomberg Intelligence analyst. “It’s an attempt to ETF-ize something that can probably never be ETF-ized. Private equity is private and real assets are illiquid.”

The funds get around this problem by limiting themselves to investing in publicly-traded companies. The methodology behind them suggests that sticking to public companies may not be a barrier to earning private equity-like payouts. Of course, this remains to be seen.

Investors can “reproduce private equity returns by carefully choosing a portfolio of publicly-traded equities with specific characteristics,” according to the index sponsor’s website. The ETFs look for firms with a low “enterprise value to earnings before interest, taxes, depreciation and amortization (EBITDA) ratio.”

Harvard Economist

Those characteristics, according to Harvard Business School Professor Erik Stafford, are the same ones real private equity firms look for, and therefore should reward investors with similar returns. Stafford has written a 51-page paper outlining his theory. That said, simply picking stocks is different from the work many private equity firms do, such as getting involved with management and helping to restructure the businesses.

Marrying private equity and ETFs isn’t new. The VanEck Vectors BDC Income ETF, ticker BIZD, holds publicly-traded business development companies, which help small and medium-sized companies grow in their initial stages, while the PowerShares Global Listed Private Equity Portfolio, symbol PSP, holds BDCs and financial insitutions.

But the USCF ETFs add a twist. Rather than invest in businesses related to private equity firms, they try to act like private equity funds themselves.

Or they may be doing something more mundane. To James Pillow, managing director at Moors & Cabot Inc., the ETFs are basically just expensive ways to buy small and mid-cap stocks. He said investors would be better off by investing in the SPDR S&P MidCap 400 ETF, ticker MDY, or in actual private equity firms through the PowerShares fund.

“This is just good marketing,” said Pillow.

— With assistance by Rachel Evans

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