Virtual private equity a step closer to reality
Jun 23rd, 2008 | Filed under: Alternative Beta & Hedge Fund Replication, Private EquityA lot has been written over the past few years about hedge fund/private equity “hybrids” where a so-called “side-pocket” is created to hold a particularly illiquid investment. But while these funds may indeed contain both asset classes, they are long and short in public equities and long-only in private equities. In other words, it is difficult to actually hedge private equity.
Of course, you could always short comparable public equities (or even an index) against a long position in private equity. In fact, given the high correlation between private equity and public equity, that might not be a bad idea. There has been some research showing that a leveraged public equity position could actually trump private equity on a risk adjusted basis (see related posting).
But insofar as private equity has its own return characteristics that are uncorrelated with public equity beta, it can’t truly be hedged.
This may be changing soon. State Street is reportedly working on a “private equity replication” model that will complement its existing hedge fund replication model (see recent posting on that one).
Eric Brandhorst, head of the research and structured products group at SSgA told Thomson last week:
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[...] Coming soon, ‘private equity replication.’ (All About Alpha) [...]