Listed Private Equity

Recently some of the most influential private equity companies are coming to the market. Actually the private equity has been in the market much longer than the Blackstone Group lists it stock at the NYSE. I believe this group of companies will become a critical part of the capital market.

At the philosophical level, there are public companies which can raise capital from the general public and their stocks are traded at major stock exchanges. There are private companies which can not access the public capital and their stock prices are not determined every day. So the duality pair can form its complete unity.

At the economic level, private equity companies can help private companies in various economic activities and make them more efficient. The overall economy can perform much better if every form of economic entities can obtain their respective capital needs purely based on their merits to the economy. The private equity can do exactly that.

At the capital market level, there are times when some public companies are severely undervalued due to various market conditions such as management problems or financial problems. However, these undervalued public companies can still have tremendous economic values if the problems are resolved. Private Equity companies serve as platforms for such changes take place. So a competitive mechanism can be formed for a smoother and more efficient capital market.

So I believe that the listed private equity or publicly traded private equity stocks will have a great future. The listed private equity (LPE) development is another contribution to the diversification of the capital market. The success of LPE will be the same just as REIT (real estate investment trust) and PTP (publicly traded partnership) have done over the years.

There are a few major players for now. Two major players which are promoting the LPE are listed below.

Red Rock Capital Partners
http://www.listedprivateequity.com/

RRCP is a Denver, Colorado based investment management firm. RRCP focuses on, develops and manages unique and proprietary investment products that complement core institutional portfolios. These products include domestic and international Listed Private Equity Index in both active & passive approaches. RRCP principals have extensive, historical and direct investment experience in both public and private equity having managed in excess of $4 billion. Red Rocks Capital Partners is the constructor and manager of Listed Private Equity Index.

PowerShares Listed Private Equity Portfolio (PSP) is the ETF which tracks the LPE Index. The Fund seeks investment results that correspond generally to the price and yield of an equity index called the Red Rocks Listed Private Equity Index. The Fund may normally invest at least 90 percent of its total assets in securities including American depositary receipts that comprise the Listed Private Equity Index. The Index is composed of a diversified mix of listed private equity companies. The listed private equity companies that comprise the Listed Private Equity Index may be selected based upon the reputation, valuation of the underlying securities, management, financial data, historical performance and the need for diversification within the portfolio.


Private Equity Council
http://www.privateequitycouncil.org/

The Private Equity Council, based in Washington, DC, is an advocacy, communications and research organization and resource center established to develop, analyze and distribute information about the private equity industry and its contributions to the national and global economy. The PEC opened its doors in February 2007.

PEC members are among the world’s best-known and most-respected asset managers. They are APAX Partners; Apollo Advisors; Bain Capital; the Blackstone Group; the Carlyle Group; Hellman and Friedman; KKR; Providence Equity Partners; Silver Lake Partners, Thomas H. Lee Partners; and TPG (formerly Texas Pacific Group).

Publicly Traded Partnership

In the past few months, two hedge fund or private equity firms (Fortress and Blackstone) have become the publicly traded partnerships. Since their IPOs, many discussions have been about their potential tax liability changes. One side of the discussions wanted to treat these two firms with the same tax liability as other corporations. Another side of the discussion would like to keep their tax status unchanged. All these discussions will not result any real changes in the tax codes just for them.

Publicly traded partnerships are very popular in recent years, especially among the energy companies. The National Association of Publicly Traded Partnerships, or NAPTP, formerly the Coalition of Publicly Traded Partnerships, is much better organized than before. The number of PTPs has almost doubled in the past three years. Now there are about half a dozen closed-end funds which are entirely for the PTPs. I personally do not think it is very easy to change the legal structure just because two firms have taken the advantages of the legal system.

There are publicly trusts, such as the real estate investment trust, or REIT, which started on shaky ground in the 1970. But over the last several decades, the REIT structure has been completely accepted in the United States. There are about 10 ETFs dedicated entirely to REITs. Its popularity is clear to investors. Its acceptance has gone beyond the United States. Its legal structure has expanded to other countries, such as in the Europe, Japan, and Hong Kong.

Why the REITs and PTPs are increasingly become accepted as normal business entities? I think the current unfair tax structure is the main reason. President’s tax changes for dividend tax have been fully integrated into the system over the last several years. It was said to reduce double taxes. REITs and PTPs are set up entirely based on the elimination of double taxation.

For regular corporations, their earnings can not be fully passed to the investors unless the corporations paid corporate income tax first. That is why there are lots of buybacks of profitable companies using their earnings. Since buybacks (to reduce available shares and therefore to increase share prices) are a good way to return corporate earnings indirectly to investors. One big difference is that corporations can retain their earnings for corporate expansions.

For REITs or PTPs, they can not retain their earnings. They have to pay out at least 90% of their earnings regularly to keep their trust or partnership status. If they need additional capital for expansions, they have to re-raise funds from the general public.

It is obvious to me that the REITs or PTPs are much better legal structure than regular corporations. It put investors at the driver seat to make new investment decisions rather to let the corporations to make the re-investment decisions. Failed companies like ERON or Worldcom were direct results of mismanaging their corporate earnings.

I feel that the PTPs just like the REITs are here to stay. Any changes to this old legal structure will only make them better for investors.

Asset Management Funds

I always like asset managers since I want to be a good one myself. Over the recent years this special asset class has caught attentions of several money managers. The following is a list of the funds (ETFs and mutual funds) related to this special asset class.

1. Fidelity Select Brokerage & Investment Management (FSLBX)
Fund Inception: 07/29/1985

FSLBX invests primarily in companies engaged in stock brokerage, commodity brokerage, investment banking, tax-advantaged investment or investment sales, investment management, or related investment advisory services. Normally it invests at least 80% of assets in securities of companies principally engaged in these activities. Normally it invests primarily in common stocks.

2. iShares DJ US Broker-Dealers Index Fund (IAI)

Fund Inception: 05/01/2005

IAI seeks investment results that correspond generally to the price and yield performance before fees and expenses of the Dow Jones U.S. Select Investment Services Index. The Index includes companies providing a range of specialized financial services including securities brokers and dealers, online brokers and securities or commodities exchanges.

3. KBW Capital Markets ETF (KCE)
Fund Inception: 11/08/2005

KCE is to replicate as closely as possible before expenses the performance of the KBW Capital Markets Index. The Fund uses a passive management strategy designed to track the total return performance of the Capital Markets Index. The Capital Markets Index is a float adjusted modified market capitalization weighted index which measures the performance of publicly traded companies in the U.S. capital market industry and includes broker dealer asset manager trust and custody banks and a stock exchange.

4. Kinetics Market Opportunities Fund (KMKNX)
Fund Inception: 01/31/2006

KMKNX seeks long-term growth of capital. The fund normally invests at least 65% of net assets in common stocks, convertible securities, warrants and other equity securities having the characteristics of common stocks of U.S. and foreign companies involved in capital markets or related to capital markets, as well as companies involved in the gaming industry. The fund is non-diversified.

5. Claymore/Clear Global EB&AM Index ETF (EXB)
Fund Inception: 06/27/2007

EXB seeks investment results that correspond generally to the performance, before the Funds fees and expenses, of an index called the Clear Global Exchanges, Brokers & Asset Managers Index. The Fund will normally invest at least 90% of its total assets in equity securities and the Fund comprised of approximately 100 equity securities traded on global exchanges, American depositary receipts and global depositary receipts of companies that operate a security exchange or brokerage asset management firm as a primary business. The index is updated semiannually (http://www.clearindexes.com/).

REIT ETFs

There are two categories of real estate related index funds: REITs and Builders. These funds have had mixed performances so far since their respective launches. In my previous blog, I had summarized the ETFs related to builders. In this blog I am trying to find the differences among the REIT ETFs. There are eight (5 US & 3 International) ETFs related to REITs:

FTY - iShares FTSE NAREIT Real Est 50 Index ETF
IYR - iShares Dow Jones U.S. Real Estate Index Fund
ICF - iShares Cohen & Steers Realty Majors Index Fund
RWR- streetTRACKS Wilshire REIT index fund
VNQ - Vanguard REIT ETF

IYR is the most diversified REIT index (including all legally defined REITs, such as commercial real estate, forest REITS such as Plum Creek, or mortgage REITs like iStar Financial). It has more than 80 components. It trades most often among investors. Its average daily trading volume of 7 million shares per day is the highest among all REIT ETFs.

ICF has only 30 components concentrated on commercial real estate companies only. However, the components are specially selected by Cohen & Steers Company. It is the most popularly held ETF in this category. Its net asset value of $2.44 billion is among the highest.

VNQ and RWR are similarly structured. These two ETFs have the lowest expense ratios (0.12% for VNQ and 0.25% for RWR). Both ETFs exclude forest REITs and mortgage REITs. So they are more similar to ICF than IYR. Since most people can own an index fund at Vanguard which is almost exactly same as VNQ. So I would prefer to own RWR in non-Vanguard accounts.

DRW - WisdomTree International Real Estate Fund

RWX - SPDR DJ Wilshire International REIT Index Fund

WPS - iShares S&P World Property ex-US

The non-US REIT index funds are relatively new. So there is no comparison between the international ETFs and other US-based ETFs. It might be an important diversifier for the REIT asset class.

Time to Buy Homebuilders?

There are three ETFs related to building and construction (XHB, ITB, and PKB). I think it is time to take a deeper look at this industry, especially when it is at its 52-week low as of today. The top five homebuilders are at its 52-week lows.

XHB (SPDR S&P Homebuilders ETF) seeks to replicate as closely as possible the total return performance of the S&P Homebuilders Select Industry Index (the Homebuilders Index). This ETF is an equal-weighted index. It has approximately 20 components, which are updated quarterly. Currently its total asset value is $200 million. Its average daily volume is over 3 million shares per day. Its management fee is 0.35%.

ITB (iShares Dow Jones U.S. Home Construction Index Fund) seeks investment results that correspond generally to the price and yield performance of the Dow Jones U.S. Select Home Builders Index. The index is a free-float adjusted market capitalization-weighted index. The Index includes companies that are constructors of residential homes, including manufacturers of mobile and pre-fabricated homes. Its total asset is $100 million. Its management fee is 0.48%. Its trading volume is about 200K shares per day, which is much less than that of XHB.

PKB (PowerShares Dynamic Building & Construction Portfolio) seeks investment results that correspond to the price and yield of an equity index called the Dynamic Building & Construction Index. The Index consists of stocks of 30 United States building and construction companies. These are companies that are engaged in providing construction and related engineering services for building and remodeling residential properties, commercial or industrial buildings, or working on large-scale infrastructure projects, such as highways, tunnels, bridges, dams and airports.

I personally like PKB due to its dynamic approach to the market. Its components are changed quarterly based on some intelligent analysis of the component stocks. However, its current asset is only $20 million and its trading volume is about 30K per day, which is much less than that for XHB or ITB.

There is some difference among PKB and XHB or ITB. XHB and ITB are related mostly to the single family housing while PKB is related to all building and construction companies including single family housing and commercial building and infrastructure building as well. There are a lot of negative news reports about the home building industry. However there is some light like Toll Brothers may consider expanding its operations in China.

If I were to purchase some shares in this category, I would buy XHB for its dominant positions in this category of ETFs.