It’s important for investors not to get too carried away with recent gains in the market, and exercise caution when choosing sectors to invest in, notes Nicholas Vardy of The Alpha Investor Letter.

US markets opened last week with two consecutive days of strong gains. Asian markets rose as well, but with less conviction.

The S&P 500 and NASDAQ indexes both bounced up off of their 200-day moving averages. The S&P 500 Index has not closed under the 200-day moving average since September 2010. A clear move above or below this level can have a significant effect on the market's future direction.

Several indicators continue to show markets as “oversold," and due for a bounce. The question: is this bounce sustainable?

Most of the bad news spooking markets over the past seven weeks persists. Chinese inflation has remained stubborn, and the words “China” and “bubble” are now appearing together in the media like never before. The Greece situation does seem to be mitigating a bit, but a long-term resolution is still years away.

Yet the markets seem to be shaking off all of this bad news. From a market-sentiment standpoint, this is a bullish sign.

Second-quarter earnings season is due to begin soon, and this will certainly have an effect on the market’s future. However, expect a weaker, more directionless market as we head into the “Dog Days of Summer.”

Although recent, strong upward movements may make some investors feel at ease with the markets, caution is still the order of the day. Market movement is currently range-bound, and it likely will be several more weeks before a defined direction emerges. It is certainly too early to become bullish.

One of the best choices now is a well-diversified ETF in a sector that is well-funded and doing well in this environment: private equity.

Tom Wolfe popularized the phrase “Master of the Universe” in his 1987 book Bonfire of the Vanities. Wolfe’s phrase referred to the Wall Street elite of the 1980s, who at that time were making their millions as bond traders on Wall Street.

Well, in the intervening 20 years, many “Masters of the Universe” on Wall Street have migrated to the mysterious world of private-equity funds. And my pick invests alongside this new group of market mavens through the PowerShares Listed Private Equity (PSP) exchange traded fund.

First, let’s start by defining “private equity.” Private equity is essentially the equivalent of “private investment.” It is an asset class consisting of equity securities (stocks) in companies that are not publicly traded on a stock exchange.

So, if you have a stake in a local restaurant as an investor—or if you have private investors in your own company—you are involved in the world of “private equity.”

Private-equity firms do not make their money by guessing price movements of various assets. Instead, they earn their keep by huddling, late at night, in boardrooms across the world, negotiating investments and restructuring privately held companies.

Private-equity funds then reap their gains by “exiting” these labor-intensive investments—often through a sale to another investor, or an initial public offering (IPO) on a stock exchange. In the meantime, private-equity firms also take their pound of flesh, by charging hefty advisory fees to whoever has deep enough pockets to pay.

Spurred by cheap money and financing during the past two decades, the very best private-equity firms have been remarkably successful. In fact, large allocations to private equity have been a key reason for the strong performance of the Harvard and Yale university endowments since the mid-1980s.

Early in its short history, PSP had focused solely on US companies by tracking the Red Rocks Capital Listed Private Equity Index, a purely US domestic benchmark. But in October of 2009, PSP switched to tracking the Global Listed Private Equity Index, thereby confirming that private equity had become a global phenomenon.

Today, PSP still maintains a 38.42% allocation in US-listed companies. But its largest allocations outside the United States include the United Kingdom, France, and Sweden.

Another unheralded advantage of PSP is its remarkable diversification. Although PSP invests in approximately 60 companies, these constituents in turn have investments in more than 1,000 firms. That means that PSP is diversified across a huge number of countries, as well as sectors.

Because each of these component holdings has interests in dozens (if not hundreds) of additional companies, PSP is significantly more diversified, in terms of both underlying holdings and industries covered, than investing in just 60 firms would indicate.

Subscribe to The Alpha Investor Letter here…

Related Reading:

Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: PowerShares DB Commodity Tracking

    Find out about the PowerShares DB Commodity Tracking ETF, and explore a detailed analysis of the fund that tracks 14 distinct commodities using futures contracts.
  2. Mutual Funds & ETFs

    ETF Analysis: PowerShares FTSE RAFI US 1000

    Find out about the PowerShares FTSE RAFI U.S. 1000 ETF, and explore detailed analysis of the fund that invests in undervalued stocks.
  3. Mutual Funds & ETFs

    Comparing ETFs Vs. Mutual Funds For Tax Efficiency

    Explore a comparison of mutual funds and exchange-traded funds, or ETFs, and learn what makes ETFs a significantly more tax-efficient investment.
  4. Mutual Funds & ETFs

    ETF Analysis: Vanguard Small-Cap Value

    Find out about the Vanguard Small-Cap Value ETF, and explore detailed analysis of its characteristics, suitability, recommendations and historical statistics.
  5. Mutual Funds & ETFs

    ETF Analysis: Vanguard Intermediate-Term Corp Bd

    Learn about the Vanguard Intermediate-Term Corporate Bond ETF, and explore detailed analysis of the fund's characteristics, risks and historical statistics.
  6. Insurance

    Whole or Term Life Insurance: Which Is Better?

    Learn the difference between term life insurance and whole life insurance. Understand when it is beneficial to buy each type of life insurance.
  7. Mutual Funds & ETFs

    ETF Analysis: iShares 10-20 Year Treasury Bond

    Learn about the iShares 1-20 Year Treasury Bond ETF and its holdings, and understand why investors may be better served to look at other bond funds.
  8. Mutual Funds & ETFs

    ETF Analysis: iShares Global Telecom

    Learn about the iShares Global Telecom exchange-traded fund, which invests in U.S. and foreign telecommunication companies with high dividend yields.
  9. Chart Advisor

    Gold Struggles to Climb Higher and May Fall Soon

    Traders will be watching the price of gold over the coming weeks. We'll take a look at how a couple major moving averages are suggesting that the next move could be lower.
  10. Mutual Funds & ETFs

    ETF Analysis: United States Brent Oil Fund

    Learn more about the United States Brent Oil exchange-traded fund, the characteristics of the fund and the suitability and recommendations of it.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  3. Exchange-Traded Mutual Funds (ETMF)

    Investopedia explains the definition of exchange-traded mutual ...
  4. Fractal Markets Hypothesis (FMH)

    An alternative investment theory to Efficient Market Hypothesis ...
  5. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  6. Sucker Yield

    When an investor has essentially risked all of his capital for ...
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
  5. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  6. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!