Listed private equity offers access… but with more volatility

Listed private equity offers a way into private markets without the lockups and capital calls, says Alan Duffy of Keyridge Asset Management. But investors must be prepared to trade smoothed returns for daily volatility.

Speaking on the Soundbites podcast this week, Duffy said listed private equity combines private market exposure, public market liquidity and operational simplicity.

“Investing in this asset class gives you access, diversification and flexibility. You’re able to participate in the economics of private markets, but you’re able to do that in a flexible vehicle,” he said.

“You can buy and sell through a very familiar mutual fund structure [with] daily pricing, standard dealing, all the good stuff that people are used to when investing in equities.”

Unlike traditional private equity funds, where early redemptions can force asset sales at unfavourable prices, listed vehicles allow investors to exit through the market without affecting underlying holdings.

But the advantages also come with tradeoffs, he cautioned.

“First of all, and most clearly, there’s mark-to-market volatility,” he said. “That means that there’s more day-to-day price fluctuations.”

Rather than the ‘return smoothing’ experienced when net asset value is calculated infrequently — quarterly or semi-annually — the price of listed private equity reflects daily assessments of company fundamentals and market sentiment.

And while that kind of volatility might spook some investors, Duffy said it also reveals price dislocations.

“It continually provides opportunities for us, as active managers, to cycle into companies or firms that we believe are well positioned or have been underpriced by the market for some reason,” he said. “It increases our opportunity set to invest.”

Another tradeoff is the need for careful manager selection.

“If you are buying shares in a listed private equity company, you’re going to be exposed to the quality of the manager’s business model — how they’re levered, their cost base, their long-term business strategy, the quality of their management, etc.,” he said. “You need to invest in a fund that’s active, where the fund managers are really getting into the weeds of picking out the winners.”

Duffy said the private equity cycle has lately entered a more mature phase.

“The era of very cheap money has gone. That’s been replaced with higher interest rates [and] more selective financing,” he said. “That has slowed down some traditional buyout models.”

Initial public offerings — the traditional exit for private equity companies — are less prevalent, he said, giving private equity companies more time to create operational efficiencies and improve the capital structure. It also helps separate stronger PE firms from weaker ones.

“You’re going to see a bigger dispersion of who’s able to harness this part of the cycle and who struggles,” he said. “That’s why active management in this sector is so important.”

Duffy said there has been an evolution of listed private equity from traditional buyout firms into much broader private market platforms. Since 2008, when the focus of the private equity bucket would have skewed heavily toward traditional buyout firms, investor interest has increasingly been in multi-product platform businesses.

“That includes things like private credit,” he said, “[as well as] infrastructure, real estate, and private equity more broadly.”

The evolution not only reflects a demand for a wider toolkit of private market strategies, but an appetite for diversity.

“In portfolio terms, you know, we get an all-weather exposure across the private assets ecosystem,” he said. “If buyouts are struggling in one part of the cycle, infrastructure may be very good. And this just gives a kind of ballast.”

Duffy said advisors and wealth managers should treat their listed private equity investments as a strategic asset allocation — albeit one driven by private market fundamentals — that should be positioned within the equity portion of the portfolio.

“Big institutions like family offices, endowments, and pension funds have been investing in this area … for years,” he said. “If you invest via listed vehicles, you can tap into that growth, but you don’t have to follow that kind of closed-door institutional framework. You get to do it in a familiar mutual fund structure.”

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This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.