Afternoon Class Group 7 Listed Private Equity

LISTED PRIVATE EQUITY
- Reviewing through indexes-

1. Introduction

Most private equity investments have traditionally occurred through funds that are not listed in any stock market. Over the last few years, increasing numbers of private equity businesses are beginning to list on stock exchanges to meet investor requirements for liquidity and transparency, and as a source of capital. These entities trade on a stock exchange, like common stock, and are subject to local reporting requirements. They are referred to as listed private equity. Listed structures may take the form of publicly listed investment companies, business development companies, investment trusts, special purpose acquisition vehicles, funds and fund of funds.

In this report, we will examine the listed private equity by comparing it to traditional private equity funds, reviewing its current status through studying S&P index and contemplating its implications.

2. Comparison of investing in Unlisted vs. Listed private

There are important differences between investing in private equity funds and listed private equity shares as follow;

Firstly, Listed private equities are more liquid and can be traded on an intra-day basis. However, the liquidity of listed private equities can vary greatly. This is not so for private equity funds, which have specific investment and withdrawal periods. Typically, private equity funds can only be purchased during a specific ramp-up period. After that, the only way to purchase the fund is on an illiquid, secondary market. Generally, funds cannot be withdrawn. Investors are paid back through distributions, which are made as the fund realizes profits from selling its constituent private equity companies. On the other hand, Unlisted private equity investors, with other LP's agreement, need to find counterparty who intend to undertake their shares through broker, GP or by themselves. However, bid price could be more advantagious because it has privatization benefit unless private equity has significant problem.

Secondly, a listed private equity portfolio is priced on a daily basis. However, this can differ from intrinsic value. Most private equity funds are priced on a quarterly or semi-annual basis, and frequently this pricing is based on the purchase prices of the constituents unless further transactions cause it to be revalued.

Third, since listed private equity stocks trade on stock markets, they have a higher correlation to stock market movements than funds.

Fourth, listed private equity can be accessed in smaller investment amounts. Much larger minimums are required for unlisted private equity funds. Even with higher minimums, many funds are only open to select, qualified investors, typically institutions or high net worth individuals.

Fifth, private equity funds express their returns as internal rates of return, which are not generally comparable to time-weighted returns.

Lastly, a greater diversity of investment types and managers can be found in the unlisted fund space. This may change over time as more private equity funds and holding companies begin to list. At the same time, holding a basket of 20 to 30 listed private equity securities may provide for better manager risk diversification than holding around 5 different private equity funds.

3. S&P Listed Private Equity Index

The S&P Listed Private Equity Index is designed to provide tradable exposure to the leading publicly listed companies whose businesses involve private equity. It is comprised of leading listed private equity companies that meet size, liquidity, exposure and activity requirements.

A. Construction

A combination of quantitative and qualitative criteria is used to arrive at index membership. Constituents must meet qualitative criteria related to exposure to the private equity business, frequency of investments and citations in industry literature to ensure that they are legitimate representatives of the private equity business. They also must meet quantitative criteria related to size and liquidity to ensure investability and tradability.

i. Index Eligibility : The universe, from which index candidates are drawn, is all publicly listed
companies in the Standard & Poor's CapitalIQ (CIQ) database with the following terms in their
business description:

1. Acquisitions
2. Business Development Company
3. Buyout
4. Mezzanine
5. Recapitalization
6. Principal Investment
7. Private Equity
8. Venture Capital

B. Market cap

Standard & Poor's analysis shows that, as of June 2007, there were about 80 listed private equity businesses trading on developed market exchanges, with market capitalization of more than US$ 250 million. This number continues to grow as more firms launch publicly traded vehicles.

C. Index status (as of December 31 , 2008)

i. Index Performance
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ii. Top 10 companies by Weight
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iii. Index portfolio characteristics
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4. Other Listed Private Equity Indexes

A. HFRX Private Issue/Regulation D

The HFRX Indices ("HFRX") are a series of benchmarks of hedge fund industry performance which are engineered to achieve representative performance of a larger universe of hedge fund strategies. Hedge Fund Research, Inc. ("HFR, Inc.") employs the HFRX Methodology (UCITSIII compliant), a proprietary and highly quantitative process by which hedge funds are selected as constituents for the HFRX Indices. This methodology includes robust classification, cluster analysis, correlation analysis, advanced optimization and Monte Carlo simulations. More specifically, the HFRX Methodology defines certain qualitative characteristics, such as: whether the fund is open to transparent fund investment and the satisfaction of the index manager's due diligence requirements. Production of the HFRX Methodology results in a model output which selects funds that, when aggregated and weighted, have the highest statistical likelihood of producing a return series that is most representative of the reference universe of strategies.

Constituents of HFRX Indices are selected and weighted by the complex and robust process described above. The model output constitutes a sub-set of strategies which are representative of a larger universe of hedge fund strategies, geographic constituencies or groupings of funds maintaining certain specific characteristics.

In order to be considered for inclusion in the HFRX Indices, a hedge fund must be currently open to new transparent investment, maintain a minimum asset size (typically $50 Million) and meet the duration requirement (generally, a 24 month track record). These criteria may vary slightly by index.

cf) Regulation D

In the United States under the Securities Act of 1933, any offer to sell securities must either be registered with the United States Securities and Exchange Commission (SEC) or meet certain qualifications to exempt them from such registration. Regulation D (or Reg D) contains the rules providing exemptions from the registration requirements, allowing some companies to offer and sell their securities without having to register the securities with the SEC.[1] A Regulation D offering is intended to make access to the capital markets possible for small companies that could not otherwise bear those costs of a normal SEC registration. The regulation is found under Title 17 of the Code of Federal Regulations, part 230, Sections 501 through 508. The legal citation is 17 C.F.R. §230.501 et seq.

B. LPX Composite Total Return

The LPX® Composite is a broad global Listed Private Equity (LPE) index whose number of constituents is unlimited. The index is well diversified across regions and LPE investment styles and represents the development of all LPE companies covered by LPX that fulfill certain liquidity constraints.

C. PrivateEqtyTrU (PRIVEXD)

The universe of the Private Equity Index comprises all stocks that are listed on a stock exchange in
Western Europe, North America, Singapore, Hong Kong, Japan, South Korea, Australia, and New
Zealand which Dow Jones covers in the Dow Jones World Index and have their largest revenue
share in the private equity area. It will be calculated initially composed of 25 components.
The Private Equity Index was launched on 9 October 2006. Dow Jones Indexes is responsible for the index calculation and maintenance.

D. Global Listed Private Equity I (GLPEI)

The Index is designed to track the performance of private equity firms which are publicly traded on any nationally recognized exchange worldwide. These companies invest in, lend capital to, or provide services to privately held businesses. The Index is comprised of 40 to 60 public companies representing a means of diversified exposure to private equity firms. The securities of the Index are selected and rebalanced quarterly per modified market capitalization weights. Market capitalization may be adjusted to represent a means of diversified exposure to private equity firms, as well as the consolidated exposure of the underlying portfolio investments. Considerations for diversification include the consolidated stage of investment (early, mid, late), type of capital (equity, debt, mezzanine, etc.), sector (energy, industrials, technology, etc.), and geography.

E. Index performance comparison (2001~2008)
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5. Benefit of Listed Private Equity Benefits

Firstly, it allows access to the best managers. As a result of the investment banking and initial public offering process, only the best private equity companies are able to become public.

Secondly, through listed private equity, Private Equity can be accessed to. Opportunities to invest in private equity funds has traditionally been available to well connected, very large institutions. These public companies are available to retail investors and institutions of all sizes with no minimum investment amount required.

Third, diversification is possible. A traditional private equity fund may invest in less than ten companies and are often concentrated by industry, stage and subject to vintage year risk. By owning a small basket of these public stocks, investors can have exposure to hundreds of companies across various industries, countries, stage of investment and not be subject to the J curve effect.

Fourth, investment horizon can be extended. Private investment funds or partnerships typically have a fixed life of 8-12 years. These public companies are perpetual investment vehicles with no set life. Therefore, investments and liquidity decisions are based on the goal of maximizing long term return for shareholders.

Fifth, better liquidity is to be offered. Equities are traded on public markets whereas private equity funds are typically purchased at the beginning of the funds’ life. Investors in funds are paid back through distributions and may not withdraw their investment.

Sixth, permanent Investment is possible. These public companies are not required to spend a great deal of time raising capital. Private funds may return proceeds of exited or sold positions back to investors. These public companies may recycle or re-invest proceeds from liquidated investments.
Seven, pricing is possible. Private equity funds and partnerships are typically priced quarterly and usually take 3 months for valuations/prices to be determined. Pricing of investments within private funds is not scrutinized to the same degree or held to the same GAAP accounting standards as publicly traded private equity companies. Within private funds there is great resistance to mark investments values downward.

Eight, reasonable Fee level is available. Managers of private equity funds typically charge hefty fees based on fund size regardless of whether investments are made and are not typically impacted by performance of investments. These public companies typically have tiered fee schedules based on success of the holding company, performance of portfolio investments, and/or the amount invested.
Nin, Time Weighted Returns are available. Private funds and partnerships measure return by internal rates of return (IRR) without consideration for time. Because public stocks are priced daily, investment returns are time weighted.

Ten, Transparency. Public companies are required to disclose financial conditions and their investments. Activities of listed public companies and estimated values of investments can be observed on a timely basis.

Eleven, Yield. Many of these public companies return investment income, dividends and interest to investors while retaining proceeds from liquidated investments.

6. Conclusion & Implications

To compare characteristics of listed private equity and unlisted Private euity, listed private equity is more helpful for generic individual investors in terms of liquidity, transparency, accessibility. But it actually is indifferent from general stock market particitipation caused by its fluctuation and risk premium. Then, why do we invest in listed private equity? One adavantage they can take from listed private equity discriminative to stock market are pocessing characteristics of invested objective, such as M&A, infrastructure, and so on. People who want participate in the Private equity market, with small money, and no negotiation power to GP, are pleased to invest in listed private equity.

On the contrary, institutional investors or super rich individual investors do not want their investment to spread out to public. Also they do not mind invest private equity for whole time period as a long term investors. Furthermore, they want to avoid beta risk which is very similarily move with general stock market with unlisted private equity for diversification effect of portfolio and target equity exposure minimization. One advantage that institutional or super rich investors can take is using IPO as one of exit tools, when they cannot find counterparty who intend to undertake their shares with satisfied price.

In conclusion, listed private equity gives more chance to individuals and institutional (or super rich people) with opposite direction.

Members :
KIM, Kyung Il (Coach)
HAN, Heeji (Editing)
LEE, Hyun-Chang (Research)
OH, JI HOON (Writing)
SONG, Byungok (Writing)

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