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ETFs Gone Wild: New Listings and What You Need to Know Before Investing


February has already seen the launch of 14 new ETFs, with several of the products representing relatively new slices of the investment landscape.

The big bang theory has nothing on the ever-expanding universe of exchange traded funds (ETFs). In fact, ETFs probably surpass it terms of size and the incomprehensible complexity of creating something from nearly nothing. While the numbers have not quite reached the billions and billions, at the end of 2012 there were some 1,250 ETFs and many are variations on the same theme. But now that the 2x-3x leverage and inverse listings seem to have been exhausted we are seeing the conjuring up of some new categories. February 2013 has already seen the launch of 14 new ETFs with several of the products representing relatively new slices of the investment landscape.

But as always, you should proceed with caution and keep the mantra of "buyer beware" in the forefront of your mind. Let's take a look at three of the recent offerings and what you need to know before investing.

Private Equity Funds

There is already a private equity ETF, PowerShares Global Listed Private Equity Portfolio (NYSEARCAPSP) which was launched in October 2006. Shockingly it actually preceded the IPO of Blackstone (NYSE:BX) eight months later. Blackstone's IPO was rightfully met with skepticism. Behind the irony of a PE firm going public (yes a permanent source of capital is nice), it did in fact mark a top as the shrewd partners were cashing out of a very overheated market.

So it is with that jaundiced eye we must greet last week's announcement that two new private equity ETFs are set to launch. The ProShares Global Listed Private Equity ETF (NYSEARCA:PEX), which invests in 30 PE firms that have at least 80% of their assets invested in private companies, and Market Vectors BDC Income (NYSEARCA:BIZD), a fund that invests in 25 business development names.

The timing of this launch seems most auspicious considering that mergers and buyouts are a "hot" sector right now as historically low interest rates are a boon for private equity firms that are highly dependent on borrowing money and taking on debt to finance deals. Basically PE firms can now borrow money for next to nothing, which means they don't need to lever up as much to achieve the same return on equity. That's nice for the partners and investors in specific PE funds, but what does that mean to shareholders of these ETFs?

Unlike the traditional unlisted private equity investments, which usually have high minimum investment amounts, are illiquid, and usually lock up your investment for some period of time, private equity ETFs provide investors with liquid exposure to the private equity asset class without minimum investment requirements, amounting to immediate exposure to a diversified private equity portfolio.

Be aware these funds come with relatively high expense ratios ranging from 2.32% to 2.56% annually and are layered with a reimbursement fee and acquired funds fees. Also, there could be issues of not only losing out on some of the return as the typical 2/20 fees get skimmed prior to bottom line earnings, but also double taxation. This is something that should be looked at with your financial advisor before making a big commitment to these ETFs.

For my money I would just as soon buy into the handful of publicly traded private equity firms such as the aforementioned Blackstone or KKR (NYSE:KKR). They have a lower cost and both have performed well, up some 30%-33% for the year to date, though it should be noted they are still down some 30% from their IPO prices. By comparison, PSP is only up 15% YTD and is down some 50% from its IPO price. This is a reflection of the fact that most indexes, or funds of funds, will have a lower beta than the component parts, but can perform equally poorly in a bear market when there is increased correlation.
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No positions in stocks mentioned.

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