The notion of private equity, what it is and how it should be viewed within the context of a broader portfolio can be a confusing topic for many investors. With the PE space growing rapidly, it’s a good time for the ETF Think Tank to talk with Jeff Knupp, the President of DSC Quantitative Group. His company provides quantitative alternative investment solutions and creates a portfolio of benchmark and investable indices seeking to track the gross performance of both the U.S. private equity and venture capital industries.
The first question posed was what exactly is the difference between private equity and venture capital. The two terms are often used interchangeably, but are there unique characteristics of each? Knupp clarifies that private equity usually targets more established businesses. Sometimes, they are simply growing quickly and need the capital to continue operations. Some are in need of help. Venture capital involves much younger companies. In many cases, they have ambitious ideas, but are still very early in the life cycle.
The discussion then turned to the state of the PE/VC market in general. Knupp states that while the COVID pandemic created a bit of a quiet period in the market, 2021 is expected to be a record breaking year. There is approximately a $3.8 trillion market cap in private equity and $2 trillion in venture capital with a lot of “dry powder” currently on the sidelines. Whereas pure play IPOs used to be the traditional exit strategy for these companies, SPACs are becoming more and more commonplace. He also notes that he expects the number of companies going back and forth between private and public to increase over time.
There is a perception that private equity generally leads to big returns. While this can certainly be the case, Knupp says that there are a lot of overexcited expectations. There are illiquidity and risk premiums that are at play, but a lot of companies never make it out of the private equity or venture capital stages. His company, DSC, looks to create tracking indexes to help manage these return expectations by being able to assess risk metrics during different market environments. Among the biggest risks are having your money tied up for many years without immediate access, high fees for active management, high degrees of leverage and a lack of price discovery.
Will rising interest rates have an impact on the private equity and venture capital markets? Possibly, but they will likely only have a modest impact. Whereas rate movements can have a more direct effect on traditional asset classes, such as banks, REITs and Treasuries, private equity is more impacted in terms of how it affects borrowing costs.
What does Knupp think you should prepare yourself for if you ever choose to invest in private equity? Keep your eyes wide open. There is a lot of risk in this space that may not be fully appreciated, but there are advantages outside of just return potential. The number of publicly-traded companies have halved over time, so you’re potentially lacking exposure to a large chunk of the market. Fintech has been an incredible area of the private equity market lately and companies offering marketplaces where you access services, such as AirBnB, have become incredibly interesting. There is a general consensus that more capital will keep flowing into these markets, which means both market cap and new investment should continue to grow.
This week we have special Get Think Tanked happy hour – a preview of the crypto debate that will take place at the etf.com awards. Come join us! As always, bring your questions.
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