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In recent years, some private equity funds have become accessible to retail investors, opening access to an attractive asset class. However, even the largest institutional investors with the deepest resources can encounter challenges when investing in private equity funds, so retail investors should be wary. Multiple layers of fees, uncertain liquidity demands and timing for capital to be returned, inability to manage tax considerations, and concentrated investments are just a few reasons retail investors should proceed with caution before commiting to a private equity fund.
However, there are options emerging for retail investors seeking to invest in private equity like an institution. In 2016, Efficient Alpha Capital began a development process to determine a way to apply methodologies used by private equity investors to publicly traded equities. The goal of this process was to take advantage of the unique ways in which private equity investors analyze investments, but without the structural challenges inherent with investments in private companies.
The solution was to create rules-based indexes that use investment models that are based on proven strategies in private equity to create portfolios of stocks that have the potential to outperform the broader market. From there, these indexes could be linked to an investment product such as an Exchange Traded Fund (ETF). In 2019, it launched two indexes in partnership with Alerian S-Network Global Indexes.
The Efficient Alpha Capital Free Cash Flow Index focuses on companies with strong free cash flow characteristics, a powerful financial metric that incorporates a comprehensive view of a company’s financial profile, including capital expenditures and working capital needs. In the end, as a shareholder of a company, one should only care about how much free cash flow it generates. After all, cash is the only thing you can use to buy anything; EBITDA, net income, and EPS are just accounting concepts. Private equity investors are particularly focused on free cash flow, since cash is needed to paydown debt in a leveraged buyout.
