The Invesco Global Listed Private Equity Portfolio ETF (NYSEARCA: PSP) invests in leading publicly traded (PE) stocks, business development companies and other related vehicles. While the start of the post-pandemic period to 2021 was a boom for the group, defined by strong investment performance and record contract business, the segment has not been immune to the current market downturn.
Indeed, the PSP is down more than 30% from its peak, reflecting the correction in asset prices as well as the more volatile macroeconomic outlook amid rising interest rates. Fee income is expected to decline this year as the environment for new transactions becomes more challenging.
That being said, the PSP looks interesting at the current level. The fund offers a quarterly dividend yielding close to 8%, supported by otherwise high-quality underlying holdings. The sale helped reset valuations for the group, which maintains a positive long-term outlook. The PSP is a good option to capture targeted exposure to this alternative asset class within the financial sector.
What is the PSP ETF?
PSP technically follows the “Red Rocks Global Listed Private Equity Index”. which uses a modified market capitalization weighting methodology that includes an adjustment with a “purity score”. This means that alternative asset managers, holding companies and investment banks that more directly hold ownership of private companies are gaining prominence within the strategy.
PSP’s current portfolio comprises 79 holdings. Within the top 10 holdings, there is a good balance with most stocks accounting for between 4% and 5% of the overall mix. The largest current positions are Blue Owl Capital, Inc. (OWL), Sweden’s EQT AB (OTCPK:EQBBF) and Britain’s 3i Group PLC (OTCPK:TGOPF). Top US private equity leaders such as KKR & Co. (KKR), Blackstone Inc. (BX) and The Carlyle Group Inc. (CG) are also among the top holdings.
An important point here is that while 60% of the PSP portfolio is allocated to “foreign” equities, it is understood that private equity is by definition a global business. For example, most large US private equity firms have significant operations and transactional activity in Asia and Europe, which highlights their cross-border exposure.
On the other hand, some smaller companies may specialize in one region or sector, but the overall effect is that the PSP ETF has good diversification with exposure to all sectors at the portfolio company level. The takeaway here is that the overall portfolio captures the high-level themes of private equity as an alternative investment class. Finally, we note that PSP has an expense ratio of 1.44% which includes a management fee of 0.5% as well as fees charged by some of the underlying fund’s holdings, consistent with the category.
We mentioned the extreme volatility of the PSP this year with the fund down 32%, underperforming the broader financial sector. Publicly traded private equity, as a market segment, has faced several headwinds. The backdrop goes back to the group’s breakout year in 2021, defined by strong global market returns, peak valuations across multiple sectors and record deal activity.
Private equity firms typically generate the bulk of their revenue from fees related to assets under management, transaction activity and a share of investment performance. The current environment has created a sort of high watermark for the industry facing tough competitions in 2021, while the correction in financial markets is still impacting earnings due to declining portfolio asset values.
Soaring interest rates pose an additional challenge as some of the investment firms use leveraged financing, which makes certain transactions less attractive. Overall, this is a poor investment environment in terms of raising new capital and investor risk appetite.
On a 2-year basis, the PSP is still clinging to a 31% return. The chart below shows it outperforming benchmarks like the Financial Select Sector SPDR ETF (XLF), which tracks broader financial stocks in the S&P 500 (SPY) for most of the pandemic rally, before giving up the gap in 2022.
It should be noted that there is the alternative ProShares Global Listed Private Equity ETF (PEX) which is an alternative to the PSP. Although they share the theme of “listed private equity”, the two funds have key differences. First, PSP has a broader strategy that includes investment companies that operate beyond just investing in private companies, while PEX has a more focused strategy and a smaller portfolio. Exposure in PSP ends up including companies that are more involved in the lending side and credit markets, which has led to higher performance over the past decade, with PSP earning a cumulative 86% vs. 64% in PEX.
On the other hand, it is clear from the chart below that the PSP has been more volatile, including the deeper correction from recent highs. Compared to PSP’s 32% decline in 2022, PEX suffered a narrower decline of 21%. While we’re not claiming that one fund is better than another, the argument we make is that PSP should be better positioned to outperform on the upside on a potential rally given its higher beta and its more leveraged underlying exposure.
The current dividend yield on PSP based on payouts over the past year is 15.2%. This figure takes into account what has been a bumper year for private equity in 2021, with record earnings driving strong payouts. The quarterly numbers are expected to maintain some of last year’s earnings momentum in the near term, but normalize to the downside going forward.
The difficulty in trying to predict a forward dividend yield for the fund, beyond the uncertainty of the level of portfolio earnings, is that the different private equity stocks in the portfolio each have a range of distribution policies. Some private equity firms have the typical constant, regular quarterly rate with a history of annual increases. Other companies have a more variable payout policy that reflects a payout ratio targeted to earnings. This results in significant volatility in the amount of the quarterly dividend at the PSP fund level.
If we assume that the dividend for the next four quarters averages around $0.20 per share, our forecast dividend yield on PSP is around 7.5%, which is in line with the fund’s average over the of recent years.
PSP Price Prediction
A bullish call on PSP currently boils down to a macro call. Risk sentiment will need to turn positive in financial markets with a general improvement in the outlook for economic conditions. Indications of an inflation spike could allow long-term interest rates to stabilize and provide some support to asset prices. On the private equity side, lower financial market volatility is essential for investors’ appetite to pick up for new trades.
The silver lining here is that the massive sell-off may have already factored in some of the worst-case scenarios. We argue that listed private equity stocks and the PSP ETF have good relative value at the current level. A catalyst could be a rally in bonds that look oversold, especially at the long end of the curve. Investors who buy PSP today are getting an attractive dividend yield.
The main risk to watch is the scenario that macroeconomic conditions deteriorate further. We can bring up the ongoing Russian-Ukrainian crisis, which is still one or two headlines away from escalating into a larger geopolitical conflict that would put all bets off the table.
The start of the year has been difficult for PSP and listed stocks. Recognizing the volatile market conditions, we like the fund as a tactical buy in hopes that this unique market segment will recover. Don’t count on the private equity guys to take advantage of the current volatile market conditions with new deals at depressed valuations to drive value in portfolio companies and for shareholders.