Why RIAs should look at PE the way PE looks at RIAs

By now, we’re all familiar with the way private equity firms have been racing toward the wealth management industry with bags of cash to buy some of that predictable fee-based financial planning income.

The influence of PE capital has been a key driver behind the record-level consolidation among registered investment advisers, and nobody expects that trend to derail anytime soon.

But as this PE-fueled pursuit of growth, innovation and scale across wealth management benefits those individuals and institutions qualified to invest in the exclusive private equity portfolios, where does that leave the smaller, retail-class investors who make up a big chunk of that predictable fee-based revenue?

Thanks to a host of political, regulatory and high-minded arguments and campaigns seemingly aimed at protecting the great unwashed masses from earning and losing money right alongside the rich folk, there are rules preventing retail investors from participating in most private equity funds.

While pressure to expand access to PE and other alternative investment strategies is growing as movements toward the so-called democratization of investing gain steam and creativity, the doors are still mostly shut to retail investors.

Two years ago, for example, when the Department of Labor issued a half nod toward allowing target-date funds inside retirement plans to include limited exposure to private equity investments, you would have thought the DOL was encouraging mom-and-pop investors to wire their assets to an unknown Nigerian prince.

Virtually in lockstep, pundits charged the DOL with throwing retirement savers to the wolves.

While the PE space is showing signs of creativity as it tries to reach the retail market, you can expect the pushback to increase in stride with anything that starts to smell like democratization.

For now, that leaves financial advisers with a short list of options when it comes to offering clients access to some semblance of private equity exposure.

The first path, which might not be ideal, comes in the form of a couple of exchange-traded funds singled out by Morningstar as providing PE exposure.

The $265 million Invesco Global Listed Private Equity ETF (PSP) and the $25 million ProShares Global Listed Private Equity ETF (PEX) each have decent performance but really high fees. The 1.44% expense ratio of PSP looks like a bargain compared to the 2.67% cost of PEX.

But high fees are often swallowed if the performance is there, and in the case of these two ETFs, it’s not.

PSP is down 9.8% so far this year, after gaining 27.4% last year and 12.6% in 2020. PEX is down 5.3% this year, after gaining 28.3% last year and losing 1.1% in 2020.

By comparison, the S&P 500 Index is down 5.1% this year, after gaining 28.8% last year and 18.2% in 2020.

Considering the performance and fees of the private equity ETFs, Todd Rosenbluth, director of mutual fund and ETF research at CFRA, suggests it might be better to think like a private equity investor and just buy the wealth management sector.

The $50 billion Financial Sector SPDR ETF (XLF), which charges 12 basis points, is up 4.4% this year, after gaining 34.8% last year and losing 1.7% in 2020.

Because of the limited partnership structure of most publicly traded PE companies, they don’t make it into the broad market indexes, which means the only other viable alternative is buying shares of the most tradeable public PE companies.

That brings us to Apollo Global Management (APO), Blackstone (BX), The Carlyle Group (CG) and KKR & Co. (KKR).

Each has its unique set of issues as PE pure plays, according to Cathy Seifert, equity analyst at CFRA, who described direct investing as the most liquid way to invest in private equity.

Seifert has a "Hold" rating on Carlyle because its organic growth currently lags the other three PE companies, on which she has "Buy" ratings.

Stock performance among the group has been mixed this year, but they're all coming off strong 12-month returns.

Apollo, which has a 2.96% forward dividend yield, is down 6.7% this year but up 36.8% over the trailing 12 months. Blackstone, which has a 3.15% forward dividend yield, is up 0.6% this year and up 88.2% over the past 12 months.

Carlyle, which has a 2.02% forward dividend, is down 9.9% this year and is up 38.9% over the past 12 months. KKR, which has a 0.87% forward dividend yield, is down 10.9% this year and up 47.9% over the past 12 months.

“I think they are still attractive, and I think it’s important for investors to focus on organic asset growth,” Seifert said. “Last year there was a strong tailwind and PE shares traded fairly well, but at this juncture, one needs to be careful.”