By Aaron Levitt on October 11, 2013
With popular social media website Twitter announcing that it will go public via an IPO later this year, the market has been abuzz with private equity and start-up companies. And there’s good reason. For early investors, a successful start-up can be worth some big coin once it hits the big time. Meanwhile, an improving economy has created a surge in buy-out and M&A activity. All leading to massive profits for those institutional private equity players that dabble in these markets.
If you’re a pension fund or other huge accredited investor, getting into this world of private equity is actually pretty easy. But what about us retail investors? Is it possible to gain from all of this activity?
The answer is a resounding yes. Luckily, for retail investors accessing this world of private equity and venture capital has never been easier for portfolios.
Big Gains For Investors
The pending Twitter IPO has renewed the general public’s obsession with start-up companies. That’s because these start-ups can turn early investors into millionaires overnight. According to investment consultant Cambridge Associates‘ two main indexes of PE returns, both private equity investors in the U.S. and those abroad have averaged nearly 13.6% in annual returns over the last 20 years. Venture capitalists- or those who just provide seed money to start-up companies- have done even better by realizing nearly 30% returns in that time.
Straight stock investors haven’t been so luckily. During the same time period, the broadSPDR S&P 500 (NYSE:SPY) only managed to produce 8.53% in annual returns.
There’s plenty of reasons to think that the party will continue going for some time. Innovation in the technology and healthcare space continues to grow rapidly, while private equity buy-outs continue to reach a fervor pace. A prime example, has been computer maker Dell’s (NASDAQ:DELL) recent $24.4 billion buy-out. All in all, CEO of buyout firmApollo Global Management (NYSE:APO) Leon Black estimates that PE investors should see low- to mid-teen returns going forward.
Given the potential for higher returns, regular retail investors do have some options for playing these markets.
Take A Look At Business Development Companies
The first place investors should look is towards business development companies (BDCs). These firms invest in or lend to small- to midsized companies and provide managerial assistance in hopes of profiting as these businesses grow. They are basically, the closest thing to a publicly traded private equity or venture capital as regular retail investors can get. Several BDCs- like Hercules Technology Growth Capital (NASDAQ:HTGC) and Ares Capital Corporation (NASDAQ:ARCC) –have been quite successful at spotting the “next big thing” in the tech world.
Secondly, due to their tax structure, BDCs are similar to real estate investment trusts(REITS) in that they are required to payout 90% of earnings as dividends back to shareholders. That results in some hefty yields- often in the 7 to 12% range.
The Market Vectors BDC Income ETF (NASDAQ:BIZD) could be one of the best ways to add the sector to a portfolio as it offers investors a broad play. The new ETF tracks 27 different BDCs and offers a hefty 7.72% dividend yield. Since inception back in February, BIZD has returned about 5%. Expenses are high at 8.33%. But much of that stems from acquired fund fees and expenses from the underlying BDCs themselves and not the fund.
Public PE Firms
The other choice for investors could be betting on the firms that are doing the buy-outs and venture capital themselves. While it won’t provide the same level of direct participation, the fees and earnings from buy-out funds and PE deals do trickle back into these firm’s pockets. Several major players like Blackstone (NYSE:BX) and Kohlberg Kravis Roberts & Co (NYSE:KKR) are now publicly traded and offer juicy yields and capital appreciation for their shares. The PowerShares Global Listed Private Equity (NYSE:PSP) can be used as a broad global play on these firms as well as provide some exposure to BDCs. The ETF yields 10.46%.
The Bottom Line
Recent hot IPOs like Potbelly (NASDAQ:PBPB) and Twitter has many regular investors salivating at the chance to participate in start-ups and private equity. With returns in the 13% to 30% range, who wouldn’t be? Luckily, the world of private equity can be achieved in a regular portfolio. For investors, funds like the ProShares Global Listed Private Equity ETF (NYSE: PEX) make it all too easy.
Disclosure – At the time of writing, the author did not own shares of any company mentioned in this article.