The People’s Mutual Fund Manager Dips a Toe Into Private Equity

(Bloomberg Businessweek) -- Vanguard Group, which manages $6.2 trillion in assets, unveiled plans on Feb. 5 to offer a private equity fund. The move represents a surprising convergence of two very different investing worlds. The Malvern, Pa., company showed millions of investors that they could beat many Wall Street pros by keeping things simple using low-cost index funds and exchange-traded funds. PE funds are the opposite of simple: They charge high fees for opaque portfolios and can lock up cash for years—which is why the U.S. Securities and Exchange Commission has long kept smaller investors out of them.

Vanguard is just dipping a toe in for now. Its offering, which will be managed by an outside firm called HarbourVest Partners, will be available only to institutions such as endowments and nonprofit foundations. But Vanguard intends to move beyond that. Chief Executive Officer Tim Buckley said in a release that for individual investors, the company’s move into private equity will eventually “present an incredible opportunity—access and terms they could not get on their own.”

Private equity funds buy up entire private companies or take public companies private. They can use borrowed money to try to juice their returns, and they can also make venture capital investments in startups or own private loans. The prospect of broader access to such investments may not be good for many investors, says Charles Rotblut, vice president of the American Association of Individual Investors. “It sounds prestigious, it sounds like they’re getting some kind of advantage,” he says. “But for a lot of individuals, getting that basic mix of stocks, bonds, and cash is hard enough.”

Vanguard has broached the idea before. In 2001 it announced a deal with Hamilton Lane Advisors, based in Bala Cynwyd, Pa., to create a fund of funds—a pool that invests in private equity funds, aimed at institutions and high-net-worth individuals. It dropped the arrangement a year later during the dot-com bust, saying it couldn’t attract enough assets.

In more recent years the PE industry has swelled, driven by investors’ hunger for higher returns in a low-yield environment and a sense that many of the best investments are outside public markets. So much money has poured in that PE firms held almost $1.5 trillion in unspent capital at the end of 2019. Even so, private equity firms have been making the case to the SEC that they should have more access to smaller investors—and the fees they would pay. At a time when some index funds have zero expenses, a PE fund can still charge as much as 2% of assets a year, along with a share of profits.

Vanguard will bring its traditional concern with costs to private equity, an area where “investor needs are growing,” says Kaitlyn Caughlin, the firm’s head of product management. But expenses shouldn’t be the only test of an investment, says Fran Kinniry, its head of private investments: “What we really need to focus on is, what does the client get to keep?” The fund industry’s concern with low fees, he says, has reached a fever pitch, with “all these zeroes and everything else—we’ve gotten so fixated.”

Proponents of private equity argue that it can improve diversification, especially as the number of public companies shrinks. “Risk means having all your eggs in one basket,” says James Waldinger, founder and CEO of Artivest, a platform for buying alternative investments such as private equity.

Vanguard’s edging in might be a sign that PE is “at the top of a market cycle,” says Kelly DePonte, a managing director at Probitas Partners, which helps raise money for private equity funds. He worries about what happens if access eventually widens beyond institutional and affluent clients. “If things go bad, you are going to have a number of unsophisticated retail investors getting into this business for the first time who don’t understand how it really works and are going to get burned.” 

To contact the editor responsible for this story: Pat Regnier at pregnier3@bloomberg.net

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