A couple of weeks ago I was invited by the guys at “The Market Traders” to join in on their weekly roundtable podcast as one of three guest panelists.  If you check out their site, you’ll see that they’re big on commodities.  Possibly a bit more of a speculative bent to their site with ads that make me think that it’s a place where stock pickers come to congregate.  However, I was surprised to find that I wasn’t the only one commenting on ETFs and my fellow panelists didn’t really spend a lot of time discussing specific stocks although a few ETFs were mentioned (not just by me).

We basically comment three times:  Once on energy, the second time on the US dollar and finally with thoughts on areas of the market that we like.  Some who have followed my writings and have become accustomed to the way I do things might be a bit surprised by my final comments.  I basically state in explicit terms how I don’t believe now is a time to think like a traditional asset allocator.  I don’t think now is the time to stick to the “60%-equity/40%-fixed income” strategic asset allocation model.  Frankly, to have a “buy-hold” mentality all of the time requires a stomach of immense fortitude.  (What you are hearing now are people from Vanguard and DFA squirming in their chairs.)  Does that mean I’m leaning towards market timing?  On the spectrum, I don’t think I’m at the far end which is market timing, but I’m certainly not at the buy-hold end.  I’d like to think that the “strategic asset allocation” process which I think is so important (cool with that Vanguard/DFA?) should, in this environment as well as others, be allowed to deviate in two ways:

1.  Allow for some tactical asset allocation.  That may mean allowing min/max constraints for asset classes to deviate even more from “home” or what may be defined as the policy allocation.  That may also mean allowing the asset allocation shifts (rebalancing, delaying implementation of cash equitization, etc.) to happen a little more frequently than normal.  This allowance for tactical decisions could actually mean several things but generally I’m saying that I believe some allowance for deviation from standard asset allocation protocols is warranted.

2.  Allow for exposure beyond the traditional asset mix.  This means to make sure that alternative investment exposures are in place.  Is it too late today for gold, oil, agriculture and other commodities that seem to be getting all the attention these days?  They’re volatile (and I believe, getting more volatile) but their diversification properties are undeniable.  Caveat:  I’m talking about exposure to the commodities via ETFs, ETNs or derivatives, not indirect exposure via equities (like gold producers).  I don’t think it’s too late to get into infrastructure and other inflation hedging asset classes and the only question is how much of these alternative asset classes is warranted as a buffer to the core of traditional asset classes (stocks/bonds/cash)?

Buy-hold philosophies for multi-asset class exposures made a lot of sense for anyone from the period of 1980 to now.  The only major hit was 2000-2002.  The big question I ask myself is whether we are still in this secular up market or did that end one year ago.  In other words, are we in a sideways or down market that has the potential to be anything as bad as the 2000-2002 bear market?  My sense is that for broad regional market exposures like the S&P 500 the answer is likely to be yes.  However, for various sectors and foreign exposures, I feel confident the answer will be no.  We’ve come out of an environment where nearly everything did well fueled by a world of cheap money.  That doesn’t mean that the pendulum will swing causing nearly everything to plummet.

A very important consideration is also the role of private equity and hedge funds given my comments above on the importance of alternative investments.  I can’t stress this enough:  As much as I am a fan of passive instruments, I’ve never said that one should completely disregard active management.  Is it hard to pick the successful managers ahead of time?  Yup.  Do they cost a lot.  More than ETFs and mutual funds but if you’re finding non-correlated returns, they should cost more.  The key question in today environment is what proportion of your portfolio do you want to allocate to market risk and how much to manager risk?

That one takes a bit of time to sink in once you really think about it.

Then you have to ask yourself, is it possible that regardless of which way I choose, it’s likely that the result will be very similar?  In other words, you put all your money in one of two possible portfolios:  All ETFs or all hedge funds … and the result is both go up or both go down!  Of course it’s possible that these portfolios go in opposite directions but that’s what we would expect and that’s why we assume the active-passive proportion decision is important.  But if they go the same way, then we’re likely to lose faith in what we were promised by someone.  The passive route promises very little.  The returns are what the markets provide.  It’s the active route that promises quite a bit more … sometime more than what was provided.  The real bummer is allocating significantly to private equity and hedge funds hoping that they will provide a buffer to the traditional core portfolio of more liquid positions but not reaching that result.  In other words over-promising and under-delivering.

Today’s deleveraged environment provides opportunities but an ever changing landscape for investors travelling the PE/HF path, some good and some bad. We hear of pension funds allocating more and more to many alternative asset classes and strategies.  I wonder if they are pleased or disappointed with their results.  Are the fees worth it?  Are managers providing alpha?  Is the illiquidity constraint more than they bargained for?  Were they too late in making asset mix shifts?  Have they improved their asset/liability situation?

Everyone is talking about credit problems (mortgage, auto, credit card) and the various tentacles of the US economy that are breaking down.  My sense is that it could be as dire as some are stating but the press is likely doing a decent job of sensationalizing the story.  But what about the pension landscape?  Low interest rates plus negative market returns of the past 12 months are bringing us back to the asset/liabiility mismatch situation we first saw during the market slide of 2000-2002.  Are these funds doing so well with their portfolio returns that the relatively low interest rate environment is not causing havoc to their books?  Is this yet another cause for concern for the US financial “infrastructure” landscape?  So many questions and I only wish I could provide simple yes or no answers.  Then asset allocation would be like ordering a pizza.

Despite the volatility we expect to find in international markets and especially in the so-called “developing and frontier markets” (I’m very much not liking those names anymore) there are so many reasons not to have anything but minimal exposure to the US whether it be equities, fixed income or dollars.  Fareed Zakaria’s commonly cited view that one must notice it’s not “the fall of the US” but “the rise of the rest” is important.  It’s important for investors because there’s a parallel to a shift in asset allocation that will surely happen … and it’s already started.  Just how much is an appropriate allocation to the emerging markets?  Defining what is or is not an emerging market or frontier market or even developed market would help in answering this.  But just as important, I believe that the simple move away from “home biased portfolios”, driven by an acknowledgment that intelligent/selective global diversification, is a necessary move in what is likely no longer a simple long-term up market.  Diversification may not be what it used to be, but along with compound interest, it’s one of the very few free lunches we investors have.

Put another way, imagine you are one of the sovereign wealth funds that the press and politicians seem to enjoy commenting on these days.  Recent allocations of these funds to western financial conglomerates (investment banks in need of capital and quickly) is a move to use some of their US dollars to buy relatively cheap assets that will provide some yield (surely negotiated to be better than what others are getting) as well as a buffer to their home grown commodity exposures.  I spend a lot of time thinking about what else is on their shopping list to diversify themselves away from existing commodity and US dollar related risks.  It’s the same exercise any investor should have with their portfolio and the positions held within it.

Lehman Brothers have now entered the ETF fray (actually, their product line up contains exchange traded notes) and they’re branded as Opta ETNs. Well this is an interesting development and one that I don’t find very surprising.

Let’s think about the ETF industry for a minute (I am aggregating ETNs and any other derivative of this type of instrument … no not that derivative … into the term “ETF”). Are we moving more and more towards alternative asset classes? Are we adding sexier functionality to products? Are actively managed ETFs on the horizon? The answer to these questions is not just “yes” but we’re basically there. If the ETF industry is less about beta and more towards something else … some alternative or exotic or “non-standard” beta and even possibly (wow!) alpha then watch out. Investment banks are going to jump in and then some.

Why wouldn’t they? Once you move away from the more traditional views of passive management, you’re moving closer to the I-banks sweet spot. The higher fees (margins) don’t hurt either.

One of the Opta ETNs covers commodities in general with a fantastic ticker symbol (”RAW”). Another covers the hot topic of the day, agriculture. And the last one brings some competition to PSP in the private equity space. Note how Lehman uses the word “Beta” in the commodity ETNs but not the private equity ETN. I agree … private equity is no asset class.

Regardless of classification, Lehman is entering the ETF/ETN space focused on alternative investments. It would not surprise me one bit if other I-banks enter in a similar fashion. Many, like Merrill Lynch have publicly spoken on their hedge fund replication products … they could be turned to ETFs. There are many ETFs that are in the middle of regulatory approval manufactured by existing ETF providers both large and small (firms that is) that, when launched in the market, would have no competition. These would be rather esoteric asset classes or strategies such as carbon credits or 130/30. Again, I-banks live and breath these markets and strategies and unlike startup ETF providers have the cash (some, thanks to their new friends, the Sovereign Wealth Funds) to make a real go at it.

If the I-banks do jump in to the ETF marketplace in a big way, there could be significant fallout. More products and more competition would make it harder for the many new entrants in the field (that are not I-banks or backed by them) to not only establish themselves but grow in a significant manner. Like mutual funds, hedge funds and other financial products, ETFs are sold not bought … just find out who makes the big money at these firms. I don’t see how the little guys could go up against a marketing machine heavyweight like a Lehman, Goldman, Merrill or Bear.

Worse still, I wouldn’t want to be a mutual fund right about now. Not only do they have to keep up with their lobby against the favorable tax treatment of ETNs but they must also be thinking about how to stop this whole active management ETF train from leaving the station. Too late … I think that was the whistle and last call.

Well, if you welcome competition (and you should), hopefully the average ETF management fee will at least go down … wait, we’re talking Wall Street I-bank heavyweights right? Check that. Don’t hold your breath.

I’ve focused so much lately on the small up-and-comers in the ETF space although I try to find reason to give kudos to the giants when they pull off something different. The recently launched infrastructure ETF from SSGA is one good example, but like Roger Nusbaum has mentioned, it’s really more of a global utilities fund.

So I find from the Financial Times “news” of Barclays Global Investors’ new private equity ETF that should have begun trading yesterday (Tuesday, March 20th). Something to go up against PowerShares Listed Private Equity ETF (PSP) which started trading on October 24, 2006. BGI has made a relatively small number of moves into the the alternative asset class space but like (IAU) which came after (GLD), this new private equity related offering fails to be first to market.
Somehow I don’t see this being a significant problem for BGI. Not because they’re big or because first to market doesn’t matter (I think it does). In my opinion, I doubt there will be much success for either ETF. The idea behind private equity investing is clear and a couple of people named Sarbanes and Oxley ought to receive sizeable paychecks from the industry for putting a killer headlock on the publicly traded markets. More like a choke hold that has greatly helped the private equity market to explode especially in the past couple of years. There has been so much discussion of institutional interest in private equity investing from funds like the Yale Endowment that I won’t dig too deep there.

But just because it’s good for large institutions, doesn’t mean it’s appropriate for the smaller ordinary investor. I think this is equally true for hedge fund investing. Like I’ve said in past postings, you can diversify (although it only helps you to a degree less than you might think), add hedging instruments (options, inverse ETFs, etc.) and other defensive measures such as simply reallocating with greater weights to cash. For many investors, especially smaller ones, hedge funds and private equity are unnecessary. It’s the bang for the buck that is missing primarily due to high fees and especially when involving smaller investable amounts.
So larger individual investors may look at these new private equity ETFs but would they or should they? I would probably lean more towards a fund-of-private equity funds … very similar in concept to a fund-of-hedge funds. Of course, there’s that added layer of fees, so the first question to ask is: Should I even bother getting into this area? This is the same question one would ask when entering any area such as emerging markets or inflation hedged bonds. But in these cases, as in most cases the question can be left to only one level: Do I invest in this area? For private equity, and in the context of this blog, the follow up question is more significant than the other examples given. The next question is: Is the ETF the way to go? This is a far tougher question when considering private equity versus US large caps or even emerging markets. In concept, I like the idea of a private equity ETF. But in terms of implementation, I’m thinking that there are more appropriate substitutes available.
What about institutions like hedge funds who I have suggested on numerous occasions in the past are big users of ETFs? I would be more than surprised to think of them using these instruments. If they wanted to get into the private equity game, an ETF would be the wrong end for them to be looking at.

So who would be interested in this type of instrument? I suppose the same investor who buys fund-of-hedge funds. And how have they done over the past 5 years or so? Investors haven’t had the returns shown in the marketing material when they got in, I’m fairly sure of that. I would only think that returns in the private equity space can’t possibly be sustained at the level they’ve been over the past few years. As is commonly the case, the moment you actually put your money down to a specific manager, a particular asset class or strategy … well, it’s usually the time it fails to deliver. Not to be pessimistic, but for every seasoned investor, you must have experienced that situation at least once in your life. I’m guessing a lot of hedge fund investors have had to re-examine their expectations in recent years. Damn this bull market!

I will certainly follow these two private equity ETFs and the flow of funds into both. In terms of trading strategy, I’d like to see how shorting them would affect a broadly diversified alternative investment portfolio. You can’t be long hedge funds, private equity, commodities, real estate and other alternatives all the time … well you can, but each can have a VERY long period of decline or close to zero returns. Perhaps an opportunistic short overlay of one of these private equity ETFs along with a few others could fine tune the alpha capture of an alternative investment portfolio. Just a thought.

Oh, it was only a matter of time before another private equity ETF came out. Any bets on when an ETF with some sort of hedge fund strategy (investable hedge fund index, replication strategy, something else) might come out?

Like their recent innovation of an ETF with a principal protection component, Societe Generale Asset Management is again moving into relatively new territory by introducing a new private equity ETF called The SGAM ETF Private Equity LPX50. Here’s the posting from Hedgeweek.com.When I say “new territory”, I am referring to private equity where, aside from the arrival of the PowerShares Listed Private EquitySM Portfolio (PSP) late last year which caused quite a bit of buzz, there is little else out there for investors aside from more direct private equity funds or “fund of funds”. However, in my piece on November 6, 2006 (Can Retail Investors Profit From Hedge Fund Access?) I did comment on the Private Equity Index (PRIVEX) and how “we may soon see an ETF linked to this new private equity index which is a collaborative effort between Société Générale Corporate & Investment Banking and Dow Jones Indexes/STOXX”. Well, SGAM has gone forward instead with LPX, a Swiss-based specialist provider of private equity research, on this ETF offering.

Here’s what caught my eye in the piece regarding the underlying index:

• “The LPX 50 Total Return Index is currently the principal benchmark reference of the listed private equity sector, offering liquid and immediate access to the 50 largest listed companies whose core activity is the allocation of private equity capital.”
• “The universe of the LPX50 Index consists of companies and funds that are listed on a recognised stock exchange and at least 50 per cent of whose total assets are invested directly or indirectly in the private equity sector, while pursuing a defined and clear exit strategy for their committed investments in order to redistribute capital gains to their investors.”
• “The index represents 70 per cent of the sector’s global market capitalisation and is diversified across all segments of private equity (venture, growth and buyout capital) and regions (Europe, the US and Asia).”
• “The LPX50 Total Return Index covers firms and funds selected not only for their size but also for their liquidity. Index composition is determined on the basis of a wide range of factors, including market capitalisation, weekly trading volume and average bid-offer spread. The index is rebalanced twice yearly.”

In many ways, this ETF looks similar to PSP, but there are some differences:

• Cost: It’s slightly more expensive at 70bps versus PSP at 60bps.

• Number of holdings: According to the PowerShares site for PSP, there are about 35 holdings as of January 30th versus the LPX 50.

• Rebalancing: SGAM’s offering is rebalanced semi-annually versus PSP which is quarterly.

• According to the new information, the SGAM ETF will have exposure to Europe, US and Asia while PSP has exposure only to the US.

I like the idea of accessing private equity with the benefits of an ETF, but I like even more the idea of global exposure. There’s been a lot press on the various downsides of private equity investing via an ETF (or at least focused on the mechanics specific to PSP), so it will be just a matter of time before similar analysis is done on this new ETF from SGAM.

With recent news of an infrastructure ETF and now more for private equity, I guess the only area left to be covered is hedge funds. There are various hedge fund indices out there… who will be first to link an ETF to one? I personally hope that doesn’t happen. A hedge fund index is a “fund of funds” being marketed as an index… but with a significant number of flaws (biases) not found in traditional indexing.

My feeling is that if you’re going to invest in hedge funds and want someone specifically mandated to run a portfolio of hedge funds, they should be given the discretion needed to manage them actively, not in the form of an index. Just my opinion.

Alternative investments are as broad and vague an area as any other within the financial services industry. I have defined for myself alternative investments to be anything other than a long position in stock or bond related holdings. Some may consider commodities and real estate should not be categorized as alternative investments since the ownership of gold and land has been a more traditional manner of investment throughout human history.The semantics of these asset classes is not important to me. What I believe to be important is how these asset classes, in conjunction with the traditional “stock and bond” portfolio, have an effect on the portfolio’s overall performance. Of particular interest to many investors in recent years are the newer alternatives of hedge funds and private equity investments.

Recently, a significant amount of buzz has been generated on the launch of a new private equity oriented ETF from PowerShares, the PowerShares Listed Private EquitySM Portfolio (PSP). There’s been considerable press of late related to the various obstacles and areas of concern regarding private equity investing. However, it is an area seeing continued infusion of institutional funds as well as that from individual investors. The ETF may just be the first step in private equity investing for the masses. From the HedgeWeek.com website, a site with a surprising amount of ETF related news, I find this recent article on a new private equity index. From the article:

The Private Equity Index [PRIVEX] provides investors with access to the upside of diversified private equity performance combined with daily liquidity.

Based on this article, perhaps PSP won’t be a “one-hit wonder” and we may soon see an ETF linked to this new private equity index which is a collaborative effort between Société Générale Corporate & Investment Banking and Dow Jones Indexes/STOXX. According to the article:

PRIVEX tracks the performance of globally listed private equity stocks and is composed of the 25 largest and most liquid stocks of private equity companies listed on the world’s stock exchanges. Dow Jones Indexes is responsible for the selection of the index components, the index calculation, the ongoing maintenance and the index dissemination.

The piece goes over the same positive attributes mentioned in press releases and marketing material for PSP including:

· Strong returns for private equity over long periods

· Uncorrelated performance to other asset classes

· Low investment minimum relative for this asset class through an ETF

· Good liquidity relative for this asset class through an ETF

· Transparent exposure

· Good diversification from a basket of underlying securities

All great qualitie,s although I continue to see new ETFs being offered with a relatively small number of underlying positions. Is this private equity index, in addition to PSP, the start of a potential trend in the alternative investment space? But wait, there’s more!

Also found this week on the Albourne Village website (Another good site for hedge fund related news. It’s free but requires registration):

01/11/2006 Fortress Pioneers First Hedge Fund IPO in US

The Financial Times reports that Fortress Investment Group, a US-based alternative investment firm with more than $24bn (£12.6bn) in assets under management, is set to file next week for an initial public offering that could value it at up to $8bn.

The Fortress IPO will be the first public listing of its kind in the US. The float will provide the first test of investor appetite for publicly traded hedge funds in the US and represents a tipping-point for the rapidly growing $1,200bn market. Hedge funds have increasingly been looking for ways to sustain their businesses and Wall Street investment banks have been increasing their exposure to the sector. Analysts said a successful float by the company could pave the way for other large hedge funds looking to form publicly traded asset management companies and lead a rush to the public market.

This type of publicly listed hedge fund instrument has evolved over a short time in the UK and now we’re getting the first glimpse of it in the US. It’s the very last few words above that I think should catch your eye: “… and lead a rush to the public market”. The continued retailization of hedge funds… one of the big debates out there today.

In addition, according to Alternative Universe, a weekly publication from hedgefund.net, Fortress is “Less a pure hedge fund than an alternative asset manager … [the firm] has $24 billion in capital under management, $13 billion of which is private equity money.” This is further proof of the ever increasing overlap of hedge funds and private equity investing, both areas where investors allow for greater manager-specific risk in lieu of market-specific risk, although in reality there’s a good dose of both.

So I pose the questions: Do retail investors need these alternative investments? Should they be getting into these instruments?

Let’s be honest here. This is a question in the minds of almost all investors considering the low return both in equities and fixed income that many consider us to be in for the next decade. Many institutions have or are going through this sort of internal debate. Others like San Diego County are having a more significant round of discussions due to “event driven” circumstances like the Amaranth blow-up.

I’ll be speaking at a hedge fund conference next week and this is one of the slides I plan on showing (click to enlarge):

There are two hedge fund indices which I use to represent the US hedge fund industry, a somewhat flawed premise but two broad samples nonetheless, along with the S&P 500. Clearly, the hedge fund industry has shown positive correlation with the broad equity market during the bull markets of the 1990s and the past four years. However, during 2000-2002, the hedge fund indices behaved more like a cash position or an equity index with an embedded put option.

So one conclusion that can be made is that, yes, hedge funds seem to perform well in both good and bad markets (they’re absolute return focused versus relative return). However, I believe one must also ask whether, in the big picture, defensive strategies such as an option overlay may provide adequate protection to major market meltdowns so that alternative investments, and the onerous process therein to select these, are deemed unnecessary? If so, then a significant amount of resources (time, money, etc.) can be saved. Or at least, the limiting of actively managed alternative investments/strategies would allow for significant resources to be allocated in just these areas which likely requires more attention than the rather “plain vanilla” long-only traditional investment holdings.

An interesting observation might come from David Swensen of Yale’s endowment fund who I believe follows just this method. His first book, Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment, basically suggested that alternative investments like private equity and hedge funds are the way to go and his performance certainly would back that up. However, he argues that a large fund like his has a very long-term investment horizon that can more adequately deal with issues such as liquidity and costs. His second book, Unconventional Success: A Fundamental Approach to Personal Investment, goes to great lengths arguing that many obstacles facing ordinary private investors set them up for failure. Not only does he not seem to be a big fan of alternative investments for private investors, he argues against mutual funds (specifically, for-profit mutual funds) as a component of the portfolio construction process and instead praises the virtues of exchange traded funds.

Because there is a wide spectrum of private investors with varying degrees of risk tolerance, portfolio size, objectives, etc. it is not sufficient to simply say alternative investments — let’s be specific and say “private equity and hedge fund investments” — are either good or bad. This is synonymous to large pension funds that are now discussing whether hedge funds should be included in their overall program. Knee-jerk reaction to funding liability concerns? Possibly, but I hope not. We would hope it is simply a reaction to evidence from the market environment (such as the decreased equity risk premium) that thereby suggests the search for alpha will provide greater assurances of properly funding future liabilities versus a reliance on market index returns.

But what if both highly actively managed strategies as well as inexpensive market returns (buy-hold ETF based strategies) can both not be relied upon in the intermediate term? A somewhat scary commentary from Bill Gross at PIMCO suggests that we are entering a beta and alpha anemic world. I highly recommend this reading although you can also listen to him read the text on his podcast.

A beta and alpha anemic world to me means that a buy-hold index strategy will not perform well, but nor will pure alpha strategies (if that’s what hedge funds and private equity investments are supposed to be).

Ouch!

Lastly, in terms of more reading, I found another recent tie-in related to alternative investments and even a reference to Yale. Jeremy Gratham of GMO LLC has some interesting commentary in their October 2006 quarterly letter:

· “Global markets are being heavily impacted by a tidal wave of diversification, with the cash flow moving predominately from the traditional areas of U.S. blue chips and U.S. government bonds into more esoteric areas. In fact the more exotic the better.”

· “This change has run into the comparative illiquidity of many new areas such as timber, infrastructure, emerging markets, and some specialized hedge fund strategies, and has moved prices up rapidly. This has reduced or eliminated the large gaps between the pricing of alternative and that of more traditional assets. Indeed, in some cases like private equity, it seems likely to have produced extreme overpricing.”

Gratham goes on to mention how the total fees paid into the investment industry has grown with the shift of focus to hedge funds and private equity related products. This has attracted talent with the effect that “finding value is harder, and even when found, it is spread thinner over more capital”. It is then no surprise that his next comment is in regard to the use of leverage by managers in the hope of maintaining past performance. His conclusion is just about as ominous as that from Bill Gross:

“The new flows into diversifying areas show no sigh of abating despite higher prices and a ridiculously small risk premium. As such, we must assume that several areas will be pushed deep into bubble territory and will eventually burst.”

It’s no wonder that GMO’s quarterly report is titled “Oh, Brave New World I” with the introductory section summarized above subtitled as “Let’s All Look Like Yale”.

So, let’s circle back to the world of ETFs and their transition away from classic market cap weighted indexation, into not only diverging methods of indexing but also a move to the broadly defined “alternative investments”. On the one hand, ETFs that allow ordinary investors into new areas and provide some, but likely not all, of the positive attributes associated with them, would seem to be the best of both worlds as described in David Swensen’s two books. A complete investment program including the use of alternatives seems to be the ideal solution for private investors, even with the possibility of using ETFs and closed end funds as the means for implementation. If this were the case, then the remaining problem would be boiled down to simple risk/asset allocation, although I think it’s rather naïve to call the allocation process “simple”. Case in point: Is now the time to add significant allocations to hedge funds and private equity?

For the investor who thinks the answer is yes and has the time/inclination to study this area, an added selection process could be built to decide what managers/products to add to the mix. Not an easy thing by any means. For the vast majority of individual investors, I would say no. For the do-it-yourselfer, there are numerous defensive strategies that can be applied on top of a well diversified portfolio including sector rotation, option strategies, inverse ETFs (or shorting futures), as well as simply moving assets to cash.

Bottom line: Hedge funds and private equity investing for the ordinary investor are apples. Hedge funds and private equity investing for the large institutional investors are oranges. Although the fact that institutions like Yale are significantly invested in this space, and this would lead many to believe that the appropriateness of these investments can apply to anyone, the problem is in the implementation. A favorable fee structure is just one thing that large institutions can “strong arm” from managers.

Already we are seeing the trend being extended to institutions having increased transparency and redemption allowances. In aggregate, individual investors simply don’t have access to alternative managers in the same context to allow for such conditions. The ETF/CEF expansion in this space could be an answer, but it’s just too early to move significant monies into these. We need more competition in this space, if not for the better attributes just mentioned above, then simply for more choice among available talent.

The upcoming ETF focused on private equity was a short bullet point from my entry on August 24th. We now have some more info — here’s what we know from these:

• ETF Eyes Private Equity
• Private Equity Comes to the Masses

· Roughly 30 positions in publicly traded companies so liquidity is not the same concern as is usual in private equity investing. Although “While the index will hold about 30 companies, Red Rocks says these 30 in turn will have investments in more than 1,000 private businesses.”

· “The new index is a benchmark of about 30 publicly traded companies that invest in businesses that participate in private equity, including private equity firms, business development companies and banks that put the lion’s share of their capital into private companies.” I’m interested to know how much of the fund will be invested in the business development companies and banks.

· The composition of the positions is based on the Listed Private Equity Index, created by Denver investment advisor Red Rocks Capital Partners.

· Minimum $50 million market cap for underlying positions. The Street’s article suggests domestic and foreign exposure but nothing more precise than that.

· There will be diversification by sector. “It will include publishing, leisure, retail, biopharma, aerospace, materials and health care, though it will change as the portfolio is rebalanced.”

· Quarterly rebalancing.

· Maximum 10% allocation for single position

· Since it’s an ETF, transparency is another benefit not often associated with private equity investing.

· Expense ratio of 0.7%. This is high in the ETF space but considering how the uniqueness of this product, I would call this reasonable.

For those who follow institutional investors, the Yale Endowment is a name commonly given as a leader in the field. I think that David Swensen’s (Yale’s Chief Investment Officer) books are required reading. His first book, Pioneering Portfolio Management, has a significant focus on the benefits of alternative investing, including private equity.

Take a look at their latest annual report on their website (.pdf).

According to the table on page 8, they have roughly 15% in private equity as of June 2005 with a target allocation of 17%. More detailed description on their private equity work is on pages 20-21. Well worth reading as a first step to those considering the addition of private equity into their portfolio.

The question thereafter is whether an ETF linked to an index is the appropriate vehicle for private equity exposure, or something more like a fund-of-funds. This would be a similar process for an investor in any alternative investment such as commodities or hedge funds.