Invesco PSP: Private Equity ETF Can Storm Back In 2023

The Invesco Global Listed Private Equity Portfolio ETF (NYSEARCA:PSP) invests across a portfolio of publicly-traded alternative asset management firms. The attraction here is that while the underlying private-equity (PE) strategies are typically reserved for institutions and high-net-worth individuals, listed PE companies offer exposure to the high-level themes for a broader group of investors.

We last covered the fund about one year ago, highlighting how private equity was exiting a banner year of returns in 2021 but faced something of a hangover in a shifting macro environment. Fast forward, PSP did indeed face volatility in 2022 but has rebounded from its lows and gained momentum more recently. The update today covers what we believe to be an improving outlook for PE which supports more upside. The PSP ETF does a good job of capturing that diversified exposure.

What is the PSP ETF?

PSP technically tracks the “Red Rocks Global Listed Private Equity Index” which utilizes a proprietary methodology to select stocks for inclusion. The idea here is to focus on firms with a principal business model of investing in, lending capital to, or providing services to separate privately held companies.

With some ambiguity in what constitutes a PE firm, the index applies a “purity score” where companies most recognized as pure-play in the industry and exert the most control in their portfolio companies gain importance. Beyond PE, the group also covers companies structured as business development companies (BDCs) and other types of financial firms. Finally, the index and fund holdings as based on a modified market-cap weighting model.

The current PSP portfolio across 58 holdings includes several high-profile U.S. segment leaders like KKR & Co. (KKR), Blackstone Inc. (BX), The Carlyle Group Inc (CG), TPG Inc (TPG), Blue Owl Capital, Inc. (OWL) and Ares Capital Corp (ARCC) and others.

That being said, what’s also interesting is the significant exposure to foreign firms and international PE names like Sweden-based EQT AB (OTCPK:EQBBF), and the UK’s 3i Group plc (OTCPK:TGOPF). Indeed, more than 60% of the PSP fund is allocated to foreign-listed PE stocks. At the same time, keep in mind that most of these asset managers operate globally through cross boarder deals or even satellite offices in other countries.

What we can say is that the various PE firms often specialize or concentrate on investments in a particular sector, like healthcare or technology. As it relates to PSP, the overall allocation has good diversification including stocks that don’t trade on a U.S. exchange. This dynamic makes the fund a good portfolio diversifier for most investors with positions in names that are typically not widely held.

PSP Performance

When looking at PSP’s historical performance, the first point is that it hasn’t necessarily been a world-beater, lagging financial sector benchmarks over the past decade. Even as private equity is recognized as delivering excess risk-adjusted returns over the long run, that profile doesn’t always translate to the stock prices of listed private equity firms which often trade based on separate dynamics.

The fund has returned a cumulative 104% on a total return basis in the last 10 years, which is nearly equal to the 105% gain by the iShares Global Financials ETF (IXG) as a reference point. The comparison with IXG is relevant considering PSP’s international profile down to the underlying portfolio investments of the PE firms. At the same time, it’s not an apples-to-apples comparison considering traditional banks and insurance firms within the financials sector have separate earnings drivers.

For context, a macro theme over the past decade has been the strength of the U.S. Dollar. By this measure, the Dollar based returns from private equity on investments made outside the United States have been pressured by the FX volatility. Similarly, European PE names have delivered lower returns over the past decade on average, based on slower economic growth.

In other words, if PSP was only U.S. listed PE firms, the performance likely would have been stronger over this timeframe. The smaller PE players in the portfolio have generally underperformed. PSP has also been more volatile since financial markets peaked in late 2021.

That being said, what’s also evident from the chart above is that PSP tended to outperform the upside, particularly during the strong bull market from the lows of the Covid crash in 2020. The fund also outperformed for much of the period between 2012 and 2019.

PSP Dividend

The other key point is that PSP distributes a dividend based on the underlying payouts for the listed-PE firms to shareholders. That said, the timing has been inconsistent over the last several years with three or four payments going back since the fund’s inception in 2006.

At this point, we’re still waiting for the 2023 distribution announcement. While the stated yield is currently 2.5%, this is skewed considering the time of the last three payments which skipped a Q4 payout similar to the case in 2018. We believe the Q1 payment will tilt higher to balance the impact.

We estimate a forward yield for the year ahead will ultimately approach a level above 3% consistent with the higher yields of the underlying holdings, recognizing the payouts on 2022 private equity fund earnings are smaller based on the weaker returns environment.

What’s Next For PSP?

In many ways, it’s understood private equity within the financial sector is cyclical with the operating environment leveraged to positive economic growth and risk appetite. From there, we make the case that PSP is well-positioned to lead higher into the next bull market and as global macro conditions rebound.

The setup here is that the underlying PSP firms enter 2023 in an evolving investing landscape that has potentially turned more attractive with opportunities where valuations have been reset lower. In other words, PE funds looking to allocate capital are finding deep discounts compared to where asset prices were this time last year or from the highs in 2021. This means that returns going forward can be higher on a lower-cost basis.

That’s a view that has some historical context. According to data from the consulting firm, Cambridge Associates, private equity investment “vintages” made during recessions and bear markets going back to the tech crash in 2001 and financial crisis in 2009 have been generally strong. While 2022 was markedly different from those two periods, the bear market did indeed materialize with asset prices selling off my more than 20%.

The other side of the discussion considers the availability of significant private equity capital to make those investments. Data from the accounting group PwC suggest upwards of $1.1 trillion in “dry powder” ready to be deployed by U.S. private equity funds. This followed what was a historically quiet 2022 in terms of deal activity and challenging in terms of conditions against rising interest rates. The trends are similar internationally.

Fast forward, it’s encouraging to see the major headwinds from 2022 recording high inflation and global supply chain disruptions now easing. The setup has opened the door for Central Banks to slow the pace of rate hikes which was the messaging by Fed Chairman Jerome Powell at the February FOMC citing signs the “disinflationary process” has started. In our view, the outlook is more conducive to generating positive returns by PE firms from existing investments and new allocations.

Final Thoughts

Putting it all together, PSP is a high-quality ETF that is relatively unique in the market. We view listed private-equity firms as a segment that can rebound higher in 2023.

From the ETF price chart, it’s encouraging to see the fund break out above the long-running down channel that was in place since 2021. Another leg higher above the $11.00 share price would help to confirm the more positive momentum. On the downside, it will be important for the fund to hold the $9.00 share price level as an area of technical support. In terms of risks, PSP remains exposed to renewed financial market volatility or a deeper deterioration in the economic environment.