You've heard the story before: The rich get richer while the rest of us try to keep up. In theory, the U.S. is a land of democracy and equal opportunity — but somehow it doesn't always work out that way.
One reason for this is the wealthy have access to investments that simply aren't available to ordinary folks. You can't catch up when you're not even on the same playing field. It's just not possible!
"Private equity" is one such investment. Now, thanks to the ETF revolution, the door is cracking open. You still can't go on the field with the big guys, but you can at least get in the stadium. Today I'll tell you how.
But first …
What Is Private Equity?
"Equity" simply means "ownership" of a business entity. Shares of stock represent equity. If you own Apple (AAPL) shares, you own equity in the company.
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Equity can be either "public" or "private." Apple shares are public. Anyone with sufficient cash is permitted to buy them on a stock exchange. Ditto for thousands of other familiar names.
That family-owned restaurant in your neighborhood? It has equity, too, but it's private. Private companies aren't always small. Some are very big and very profitable. Forbes magazine publishes an annual private company ranking using estimated revenues. Here are last year's top five.
- Cargill (farm products) $109.8 billion
- Koch Industries (chemicals) $100.0 billion
- Bechtel (construction) $30.8 billion
- HCA (hospitals) $30.1 billion
- Mars (candy) $28.0 billion
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|Cargill is a big company, but you can't buy their stock.|
As you can see, these are big companies by any definition — bigger, in fact, than many publicly-traded stocks. But they aren't represented in most investment portfolios because they aren't for sale.
Sometimes, however, private companies need outside financing. Or maybe the founders are just ready to move on. The process of "going public" is complicated, time-consuming, and expensive. So the owners do what wealthy people have always done: Turn to their friends by selling "private equity."
The result is a kind of hidden stock market for elite investors. The lines between "equity" and "debt" are blurred into ever-more-creative transactions with elements of both. Private equity funds make private deals with private companies in private meetings.
|What are they talking about? You'll never know.|
Results? That's private, too. But we can be pretty sure — judging by the size of the wheeler-dealer estates — there is plenty of money to be made in private equity. And it's all perfectly legal, thanks to loopholes in the securities laws.
ETFs: Your Foot in the
Private Equity Doorway
The invention of exchange-traded funds and exchange-traded notes opened up this once-clubby little market. The entrance is still small, and your ticket won't get you into every nook and cranny. It's a good start, though.
One term you'll hear a lot is "business development company." A BDC is a publicly traded entity that invests in private equity and debt and is registered as a BDC under the Investment Company Act of 1940. The typical BDC lends capital to small and mid-sized companies at relatively high rates. The BDC often takes an equity stake as well.
Like venture capitalists, a BDC often takes an active role in guiding the companies in its portfolio. The expertise and connections can be very useful.
Since the BDC is itself publicly traded, you can buy shares in the same way you would any other stock. The same is true for some of the larger private equity fund sponsors.
As with other specialized niches, ETFs and ETNs give small investors convenient, diversified exposure to the private equity/BDC segment.
The original entrant to this space was PowerShares Listed Private Equity (PSP) in 2006. More recently, a pair of ETNs joined the list. They are:
- UBS ETRACS Wells Fargo Business Development Company ETN (BDCS)
- UBS ETRACS 2x Leveraged Long Wells Fargo Business Development ETN (BDCL)
These names are quite a mouthful. At least they're descriptive. Both attempt to reflect the results of a Wells Fargo index of BDC stocks. BDCL adds a 2x monthly leverage factor.
(Editor's note: To see how Ron uses ETFs to help his International ETF Trader subscribers achieve the ultimate in diversification, watch this FREE video.)
If you look up the stats on any of these tickers, pay special attention to the dividend yield. The numbers are eye-popping. BDCS is currently yielding about 7.7 percent while BDCL's yield is estimated to be about 17 percent.
Why such high income?
As I said, the underlying private companies are sometimes very profitable. They aren't that profitable, though. The yields are high because this is a risky, volatile market segment, and the BDCs are often rewarded for taking that risk.
Whether you should or shouldn't invest in one of these products is a personal decision for you. Anyone with a long-term growth portfolio should definitely take a look, though. Private equity is a neglected but potentially very useful alternative.
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