Liquidity
Analysing the liquidity of these ETFs we can see a recent pick-up in on-exchange trading volume of the db x-trackers ETF. Over the last 12 months, trading volume exceeded £1.8m per month on only two occasions. However, in January 2011 volume more than doubled to about £4.5m on the London Stock Exchange, the ETFs most liquid listing. Trading volume during the first half of February has already reached about £4.2m. Looking at the iShares ETF, volume has picked up steadily over the last few months on the London Stock Exchange; almost doubling from £1.3m in October 2010 to a peak of £2.8m in January 2011. The Lyxor ETF however does not seem to follow a similar trend on the Euronext in Paris. The PowerShares ETF is the least liquid of the group, going through some months without printing a single trade on the London Stock Exchange. Volume for this ETF picked up quite substantially in December 2010 and January 2011, only to go quiet once more during the first half of February 2011.
Liquidity is a very important factor to consider when investing in any security. Investors can buy and sell liquid assets quickly and at minimal cost and therefore can act on news or changing market environments without having to worry about buying at premiums, selling at discounts, or the entry and exit fees and other frictional costs that are all associated with less liquid investments. A direct investment in PE usually comes with high entry and/or exit charges and lock-up periods of several months or even years. Even though ETFs offer a more liquid way to access to private equity, the data above show that they are still highly illiquid—as measured by on exchange trading volume. We recommend the use of limit orders when trading shares of these ETFs on exchange. Any trade that represents a large portion of daily on-exchange volume may best be conducted with the help of a market maker.
Recent Returns
We’ve seen that these ETFs’ liquidity has generally been increasing over the last couple of months, but how have these products been performing?
The above data suggests that investors in these ETFs would have outperformed broad equity and fixed income benchmarks over the past two years–albeit at the price of higher volatility. If we look back further to include 2004, three of the four ETFs would have underperformed the MSCI World whilst exhibiting much higher volatility.
Diversification Potential
Correlation between asset classes is a very important consideration when constructing portfolios. Adding securities with a low level of correlation to an existing portfolio can improve the portfolio’s risk/reward ratio. The above data suggests that, during the period in question, an investment in private equity ETFs would not have been of much benefit from the a diversification point of view. The reason is simple. As listed private equity firms operate in the same economic environments as publicly traded companies they face many of the same trading conditions and regulations. Moreover, PE firms ultimately generate value by selling their portfolio companies and other investments for a profit. Hence, the wellbeing of PE companies depends highly on the overall health of the economy; e.g. phase of the business cycle, access to credit, etc. Given all these characteristics the high correlations between private equity and more broad-based equity benchmarks seen above should come as no surprise.
On a Final Note
Private equity ETFs may not necessarily give investors the exposure they are after. To unlock the real promise of PE, namely expectations for above market returns and low correlations with other asset classes, investors’ best bet is probably still to put money into direct PE investments which are only within reach of the institutional and ultra-high net worth investor.
Hence the ‘untouchable’ remains out of reach for most of us.
