How to invest / participate in next uber stock Uber is believed to be worth about $70 billion. From outside the company, there is no way to obtain precise information about the financials. That makes it impossible to determine the exact worth of the company.

That’s not true of all companies. We could, for example, determine how much Apple is worth in a number of ways. As investors, we could add up the value of all outstanding shares in the company. Or, we find the total enterprise value of Apple by considering the value of stocks and bonds that are issued.

It is important to note here that we are referring to the company’s price in the marketplace. This isn’t the company’s value from an investor perspective. It’s merely an accounting exercise to determine what all of the company’s current investors have put into the company.

For Uber, that’s not possible for anyone outside the company without Uber’s permission. Uber is a private company and as a private company, it is not required to share its financial information or discuss anything about its operations.

Despite the lack of information about its operations, the company is estimated to have a valuation higher than 80% percent of the companies in the S&P 500.

This growth has been made possible because Uber does have investors. The company makes deals with private equity investors to fund its growth. And, these private equity investors are enjoying the growth in Uber and other startups before the public has a chance to buy the stock.

What is Private Equity?

Private equity is an investment category consisting of large investors that make direct investments in private companies. Occasionally, private equity will invest in public companies, buying out all of the other investors and taking the company private.

The funds for these deals comes from institutional investors and accredited investors. The meaning of this term is defined by the Securities and Exchange Commission which says, “An accredited investor, in the context of a natural person,
includes anyone who:

• earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year,

OR

• has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence).”

Based on these tests, it’s reasonable to assume that accredited investors are individuals with considerable risk.

Private equity can be used to fund new companies, as is the case with Uber and many other tech companies. It can also be used to take companies as was the case when Blackstone bought out Hilton Hotels for about $9 billion in 2007.

Blackstone proceeded to restructure the company’s debt and brought in skilled managers who improved operations. When Hilton went public again in 2013, it was worth over $12 billion and Blackstone made billions of dollars.

Other funds make targeted investments like the T1D Venture Philanthropy Fund which has invested $32 million to make high-impact early-stage investments to accelerate commercial development of life-changing therapies for people living with type 1 diabetes.

Historic Returns Top Stocks and Bonds

What makes private equity investments so appealing to investors is their rate of return. In the long run, as an asset class private equity has significantly outperformed stocks and bonds.

Source: Cambridge Associates

These returns are so high because there is a great deal of risk involved with private equity deals. In cases where the investment is in a startup company, there is no guarantee of success. Many startup companies fail and many others deliver mediocre returns.

But, there are, of course, some large winners among startups and a single large investment in a company like Google, Facebook or possibly Uber could dramatically improve the track record. Private equity can also deliver large gains in biotech or any other sector.

Patriarch Partners, LLC, is a private equity firm with investments in more than 75 companies across 14 industry sectors. Founded by Lynn Tilton in 2000, Patriarch was built upon a proprietary patented financial model designed to manage and monetize the distressed portfolios of financial institutions.

The company focuses on mundane businesses and current investments include Dura Automotive, Performance Designed Products, Universal Instruments, Spiegel Catalogs, MD Helicopters, Rand McNally, and Stila Cosmetics.

Its founder has increased her investment from $10 million to more than $500 billion over 20 years.

Patriarch’s returns demonstrate the potential for private equity investments in stark terms. In recent years, it has become possible for ordinary individual investors to add private equity to their portfolios. This is possible through ETFs or with a direct investment in the largest firms.

Buying Into Private Equity

Among the simplest ways to add private equity to your portfolio is with the PowerShares Global Listed Private Equity Portfolio (NYSE: PSP), an ETF that provides exposure to the industry. An ETF, or an exchange traded fund, is an investment fund that invests in other companies.

PSP is a fund designed to track the Red Rocks Global Listed Private Equity Index (Index). The fund will normally invest at least 90% of its total assets in securities, which may include American depository receipts and global depository receipts, that comprise the Index.

The Index includes securities, ADRs and GDRs of 40 to 75 private equity companies, including business development companies (BDCs), master limited partnerships (MLPs) and other vehicles whose principal business is to invest in, lend capital to or provide services to privately held companies (collectively, listed private equity companies).

PSP’s largest holdings are in non-US based private equity investments. This provides investors with a diversified investment that is not directly tied to the US economy. The performance of the fund has been significantly better than the S&P 500 in the bull market. But, the fund lagged in the bear market.

PSP has nearly doubled the gains of the S&P 500 since the stock market bottomed in 2009. However, the ETF lost about 160% of the decline of the S&P 500 in the prior bear market.

This chart highlights the rewards and the risks of private equity.

Another way to invest in private equity is with one of the world’s largest private equity firms, The Blackstone Group, L.P. (NYSE: BX). This stock has gained more than 1,400% since the market bottom.

Blackstone began trading in 2007 and lost 89% in the bear market in its short history.

These two charts place the asset class in perspective. Large returns are possible in private equity, but the risks are also high. Despite the risks, the investment could be worth considering.

Perhaps the best approach for many investors is to consider adding private equity to their portfolio during bear markets. When the next downturn comes, history tells us to expect losses in the industry that are larger than the losses of the broad stock market averages.

The large losses make perfect sense. In a downturn, there will be many business failures. Private equity seeks out exposure to the riskiest investments.  In an economic downturn, distressed companies and startups will face the same challenge. Obtaining cash for operations will be difficult.

However, in a bull market, some of these startups and turnarounds will be among the biggest winners as the economy expands.

The ability to hold private equity in a bull market but not a bear market provides individuals with an advantage over accredited investors who face long lockup periods on their investments. One approach could be to buy BX or PSP when they are trading above their 200-day moving average.

Selling when the price of BX or PSP closes below its 200-day moving average could help investors avoid losses of 90% or more experienced in the last bear market.

Best Performing Hedge Funds are Minimum mysterious Investment for many investors. They are open to select investors, those who meet the legal requirements as accredited investors, can meet minimum investment amounts that can top $5 million at the best fund and agree to lock up periods that can run for years

If you qualify to invest in the fund, you will then pay for the privilege. Many fund managers charge a management fee of 2% a year and then take 20% of the profits. This incentive fee can be structured in different ways and might not be as bad as it sounds.

Most funds only charge the incentive fee when they are making new highs. If a fund loses 10% in a year, for example, they would need to recover those losses before they could take a percentage of the profits.

Other funds only take a share of the profits that exceed a benchmark. If a fund, for example, gained 30% in a year when the S&P gained 5%, the manager would make 20% on the 25% of gains that beat the benchmark.

The largest funds and those with the best track records could take even more in fees. One fund manager, Renaissance Technologies, is rumored to charge 5% in annual management fees and an incentive fee of more than 40%. But, the fund is closed to new investors.

Performance Drives the Fees

Accredited investors are sophisticated investors. The meaning of this phrase is defined by the Securities and Exchange Commission which says, “An accredited investor, in the context of a natural person,

includes anyone who:

• earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year,

OR

• has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence).”

Based on these tests, it’s reasonable to assume that accredited investors have access to good financial planning advice. While individual investors avoid funds with high expenses, these investors are at times encouraged to pay the high fees.

One reason to pay so much is for performance

According to Bloomberg, the fund “has become probably the world’s most successful money machine. According to Bloomberg, the fund “has become probably the world’s most successful money machine. Powered by millions of lines of computer code, it has made about $55 billion over the past 29 years, thanks to average returns after fees of an astounding 40 percent.”

Source: Bloomberg

A $1,000 investment in the fund at inception would be worth more than $13.8 million at that rate of return.

Not all hedge funds perform like Medallion but investors in this arena are always looking for the next great fund.

Defining a Hedge Fund

A hedge fund is considered an alternative investment that is beyond the typical investment categories of stocks, bonds, real estate and collectibles. Hedge funds can often investment in anything and they often use leverage in an effort to boost returns.

The name comes from the first funds that were formed in the late 1940s. These funds were designed to decrease the risk in holding long term stock positions by selling short stocks the managers believed were set for a decline.

Early funds, in other words, hedged the risk of the stock market by seeking to benefit from declines. They also used leverage, or borrowed money, to increase the potential returns of the funds. The early funds generally performed well in a difficult market environment.

Their success, as almost all success on Wall Street does, led to imitation and competition. Many other managers rushed into the field and they added strategies. Soon funds were available to their select group of investors offering a variety of objectives:

• Traditional hedged equity funds buy stocks they expect to outperform and short stocks expected to decline in value. This strategy is also known as a long/short strategy.
• Market neutral hedge funds use stocks to create a portfolio that is expected to deliver returns with little volatility. These strategies often use Treasury bills as their benchmark and target returns that are slightly better than that
• Arbitrage funds use different securities in different markets that are expected to converge to a similar value. Through a series of long and short trades the managers seek to capture short term pricing differences in different securities or in different markets
• Distressed investment funds are looking for companies that could fall into bankruptcy. They then use their professional and legal teams to deliver profits on those securities.
• Global macro funds look for trends driven by major news events and may invest in stocks, bonds, currencies, futures or any other investment they believe will benefit from that trend.

There are also fund of funds, or FOF, in the hedge fund world that invest in a number of other hedge funds. A FOF may invest in dozens of funds to provide diversified investments to hedge fund investors. This is useful since the minimum investments can be high and the best funds may be closed to new investors.

Accessing Hedge Funds If You Aren’t an Accredited Investor

As with any investment management activity, indexes have been developed to track the performance of hedge funds. The introduction of indexes has helped make hedge fund investments available to individual investors.

Exchange trades notes (ETNs) tracking hedge fund indexes are traded like the more common exchange traded funds (ETFs). The difference between the two is that ETFs will use the assets under management to buy shares of individual stocks while ETNs will use funds to buy derivatives. They both trade the same way.

The IQ Hedge Multi-Strategy Index Fund (NYSE: QAI) is an ETF designed to replicate the risk-adjusted return characteristics of hedge funds using multiple hedge fund investment styles, including long/short equity, global macro, market neutral, event-driven, fixed income arbitrage, and emerging markets.

Unlike many hedge funds, individual investors can invest in QAI. The fund has more than $1 billion in assets. Its performance relative to benchmark indexes is shown in the table below.

Source: Fund Fact Sheet

This fund has underperformed the S&P 500 index since its inception on April 1, 2009. The industry standard benchmark, the HFRI FoF Composite Index, has also trailed the S&P 500 over that same time. This is actually not unexpected.

In a strong bull market like the one we have seen since March 2009, active managers are at a disadvantage. Their fees and costs contribute to underperformance as does their investment style. Active funds will seek to manage risks and in a strong bull market their defensive actions will hurt performance.

That’s why many investment managers urge investors to consider performance over a full market cycle which includes one full bull market and one full bear market. In the past two bear markets, the HFRI FoF Composite Index outperformed the stock market averages.

Between 2000 and 2002 as the stock market dropped by almost 50% as many stocks did far worse, the index delivered a gain. The index gained more than 20%. In the bear market that ended in 2009, the index declined less than half as much as the broad stock market averages.

This performance shows the value of a FoF in a portfolio. This is why large investors and institutions have owned hedge funds even through extended periods of underperformance. That is why we sought to introduce you to hedge funds in this article.

However, in future articles we will be highlighting alternative investment opportunities that have delivered strong performance.