How to Play Publicly Traded Private Equity Funds

 | Jul 25, 2016 | 12:00 PM EDT
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Stock quotes in this article:

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I was asked recently what I would do if I had money that absolutely had to go to work today and community banks were off the list. I spent a lot of time thinking about that and decided that I would put it into the "Big Four" publicly traded private-equity funds -- Apollo Global (APO) , Blackstone Group (BX) Carlyle Group (CG) and KKR (KKR) .

I already own shares in all four, and it's no secret that I love the private-equity business and think it uses the right framework for long term investing. While only KKR has a fixed dividend policy that currently pays about a 4.6% yield, the other three have historically paid a high percentage of distributable earnings to shareholders. So, this is a fairly high-yielding group of companies.

All four of them also use their balance sheets to seed and invest in various private-equity, alternative-asset and real estate portfolios, so there's the strong possibility of long-term growth from the high returns that those asset classes usually earn. Fees that the firms collect along the way should also drive their dividend payouts and stock prices higher as well.

But rather than just purchasing these four stocks outright, I'd be a "sneaky buyer" and use cash-secured put-selling instead. It looks like if I went one strike down and two months out, I could sell September puts in all four of these stocks for a decent premium that would result in a 3%-4% return on my cash position. I would simply do that until the stocks fell below my strike prices and I got "put" into the shares at lower levels than what the shares trade at today.

I would then turn to the closed-end funds that these private-equity companies run and buy shares of those that offer big discounts to net asset value. After all, large alternative-investment firms have decades of experience in leveraged lending, so their closed-end funds should benefit from the relationships that these portfolios have with their respective firms.

The Blackstone/GSO Long-Short Credit Income Fund (BGX) and Blackstone/GSO Strategic Credit Fund (BGB) both offer about 10% discounts to NAV and more than 8.5% yields, so I'd start with them. I'd also add the Apollo Senior Floating Rate Fund (AFT) if any market disruption boosted its discount to NAV closer to its historic 11% average.

Next, I'd look to buy some of Big Four's longer-term credit offerings, like the Apollo Tactical Income Fund (AIF) . This blend of senior loans and longer term bonds currently trades at a roughly 10.7% discount to NAV, but boasts better than a 10% distribution yield.

The KKR Income Opportunities Fund (KIO) offers a similar structure, but only had an 8.6% discount to NAV at last check. So, I'd wait for a double-digit discount before buying that fund.

Lastly, I'd add some shares of Apollo Investment (AINV) , my favorite private-equity-affiliated investment.

AINV is a business-development company that's affiliated with Apollo Global, and I've owned its share for a long time. However, I've seen its price swing all over the place since my original purchase. My cost basis is more than $5 a share (not far from the stock's current $5.70 or so), but I've collected well in excess of that through dividends over the years.

Buying the stock today means you'll also get $7.28-a-share in net asset value, as AINV currently sells at about 78% NAV. You'll also receive about a 14% dividend yield, and I think those willing to hold on the the stock for a very long time will see fantastic returns.

The Bottom Line
I have no institutional mandate to be fully invested, so I don't have to jump in the market this very second. But if I did, I would put any excess capital into the four publicly traded private-equity firms above.

I'll be watching these companies report quarterly earnings over the next two weeks. If they fall short of expectations and sell off, I'll plan to add to my stakes.

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