ETFs have long been defined by their liquidity, low cost and transparency, but those hallmarks are being tested as the industry looks to bring private assets into the ETF wrapper.
Interest in opening access to private assets has accelerated over the past year, fuelled by a series of landmark launches and industry moves.
Europe’s first CLO ETF debuted in August last year, drawing scrutiny over the risks of bringing what many view as illiquid private loans into the wrapper.
In the US, State Street’s partnership with Apollo on a private credit ETF brought these issues into sharper focus and raised the question of whether similar structures could emerge in Europe.
Since then, white-label issuers such as HANetf and Waystone have reported growing interest from managers eager to package private assets in an ETF.
Increasing momentum in the space has prompted a growing number of index providers to explore how private equity could be effectively benchmarked.
FTSE and global private markets firm StepStone announced in June they are working to build a new suite of private asset indices, data and analytics tools based on StepStone’s private markets data.
The MSCI World Private Equity Return Tracker index launched the month after, designed to mimic the performance of private equity by using listed equities.
Private equity benchmarks may be enjoying fresh attention, but they are hardly new. ETFs tracking listed private equity indices have been around for well over a decade in Europe.
The $1.6bn iShares Listed Private Equity UCITS ETF (IPRV), launched in 2007, the $373m Xtrackers LPX MM Private Equity Swap UCITS ETF (XLPE) from 2008 and the more recent $223m FlexShares Listed Private Equity UCITS ETF (FLPE), launched in 2021, all follow one of the two approaches to indexing private equity.
These funds track the performance of listed private equity firms - groups such as Blackstone or KKR - and use them as a proxy for the asset class.
This is one of two main approaches to indexing private equity. The other aims to capture the performance of the underlying, unlisted companies themselves by replicating their risk and return profile with publicly traded firms.
This is what the MSCI World Private Equity Return Tracker index does. The benchmark leans on MSCI’s Private Capital Universe to mirror the regional, sector and style exposures found in private equity portfolios, layering in factor tilts such as value, momentum, growth and size.
The result is a more complex, data-driven methodology designed to approximate the behaviour of private equity in a form investors can actually trade.
The growing discussions around indexing private equity raises many questions on how it should be done, which proxies work best and who will ultimately crack the challenge of the most effective way to index private equity.
Do factors have a place in private equity indexing?
The role of factors in private equity indexing is up for debate.
On one side, they offer an alternative to simply tracking listed private equity firms, a method that both Peter Diel, head of index product for Europe at Vettafi, and Tobias Sproehnle, CEO and co-founder of PANTA, argue is a poor proxy for the asset class.
Diel highlighted the limitations of using listed PE groups as alternatives.
“It is not 100% accurate, because not all of these firms invest solely in private equity, many also run other business lines,” he said. “So it is not a pure reflection of the private equity universe.”
Sproehnle echoed this view. “The biggest problem with using listed PE firm’s stock prices I see is that there are so many factors in these stock prices that I think these are almost useless as proxies,” he said.
“In my opinion, a mix between observed prices of PE enriched with proxies like publicly traded equity is the best substitute that you can get at the moment.”
The second approach - trying to capture the performance of unlisted companies by using public firms with similar characteristics - comes with its own set of challenges.
Factor tilts, such as small-cap exposures, have been tried but are far from perfect, Diel argued.
“Private equity companies are usually startups, so the natural approach was to take small caps as a benchmark,” he said. “But in the end, the correlation is not high enough.”
The problem, he added, is the lag in reporting private equity performance.
“Small caps react way faster. If they sell off sharply, you might only see that reflected in private equity valuations three months later.”
While some private equity investors still use small-cap indices as rough benchmarks, in practice the timing mismatch undermines the overall correlation.
‘A race to the moon’
What is clear is that multiple players are vying to be the first to crack the challenge of the most effective way to index private equity.
“Everyone is looking at it, it is like a race to the moon”.
While there are “different approaches,” Diel argued from “a very puristic way of thinking, every proxy cannot keep up with the reality.”
The core issue, he said, is how to accurately reflect the value of private equity companies when there is no reliable pricing.
“Maybe it is a conundrum which will be never solved,” Diel said, “Unless we find a way to consistently price and value these companies before putting them into a basket or an index.”
Final word
Recent acquisitions illustrate broadening access to private markets is top of many asset managers’ agendas, whether this be offering professionals listed vehicles to tap niche corners of private credit or retail investors stakes in – or derivatives of the performance of – their favourite private companies.
It remains to be seen whether ETFs will be the vehicle of choice to continue opening up this access; the efforts of index and data providers will be central to this conversation.
