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Fund Spy

Private Equity Funds for the Masses

What investors should know before they dive in.

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Once reserved for the very wealthy and ultra-patient, illiquid investments such as rare earth metals, defaulted and distressed bonds, and nontraded REITs are increasingly being packaged in liquid wrappers. This movement's latest incarnation is sponsored by the private equity community. Private equity firms including Carlyle Group (CG), KKR & Co (KKR), Apollo Global Management (APO), and  Blackstone Group (BX), have all either recently filed for or have launched retail products that aim to better diversify portfolios. Before investing in these new products, however, investors must understand the premise of private equity, and the relationship between the liquidity of the underlying investment versus its packaging.

In exchange for locking up your money for seven to 10 years, traditional private equity funds expect to offer a higher rate of return than the listed stock market (this extra return is called a liquidity premium), with a relatively low correlation (as the private and concentrated nature of the investments prevent them from moving closely with the listed markets). Private equity funds largely have met their goal: Cambridge Associates U.S. Private Equity Index, for example, returned twice as much as the S&P 500 between April 1997 and September 2012 (13.6% net of fees versus 6.1%, respectively), with only a 0.78 correlation (using quarterly returns).  

Nadia Papagiannis does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.