Should You Buy a Fund of Private Companies? What Investors Need to Know

Wall Street is removing the velvet rope from a once-exclusive club. But is the party inside worth attending?

News this week has investors asking that question—in this case, about putting money in companies that haven’t gone public yet. Robinhood (HOOD) wants to open up access to private equity for retail investors through a closed-end fund, which raises capital through an IPO and trades on an exchange like a stock.

The move has drawn attention at a time when some private companies sport massive valuations, leading to excitement about what could be massive IPOs. Firms have touted the benefits of private equity in portfolios, saying they enhance diversification and offer higher potential returns historically available only to well-heeled investors. Funds run by star portfolio managers often hold investments in private companies alongside public ones.

Robinhood’s goal, CEO Vlad Tenev said Tuesday, is “not just to open the doors to private investing, but to blow them completely off the hinges so that no one can close them ever again.”

The Robinhood Venture Fund is expected to list on the NYSE in the coming weeks under the ticker “RVI.” Anyone can buy shares, getting access to the companies the fund aims to invest in—including wearable tracker provider Oura Health, expense management platform Ramp and AI startups Databricks and Mercor.io, per RVI’s prospectus.

The buy-in, $25 per share, may seem enticing. But there’s no guarantee the fund will deliver the returns to make an investment worthwhile. And some institutions and university endowments—well-heeled investors that have long invested private equity—are starting to lean away from the private markets after seeing disappointing returns.

Oregon and Washington’s state pension funds recently lowered their target allocations to private equity. And per a Wall Street Journal report, Princeton is lowering expectations for its endowment returns because its private-capital investments have started to lag the broader market, while Harvard is cashing out of its holdings early.

A 2020 academic study by Ludovic Phalippou, a professor at Oxford University’s Said Business School, found that private equity funds have returned about the same as broad market stock indexes since at least 2006. Meanwhile, expenses have eaten into those returns: Phalippou estimates that funds raised between 2006 and 2015 collected some $230 billion in performance fees.

The Robinhood Venture Fund, won’t charge a performance fee, but the mechanics of closed-end funds and the other fees that it will charge—an average weighted sales load of 3.125% and a 2% annual fee—will compress returns, according to University of Florida professor and IPO expert Jay Ritter. (Robinhood said it would temporarily cut the annual fee after launch.)

If investors buy one share at $25, they will effectively get $24.22 of net asset value after accounting for the sales load, Ritter said in an interview with Investopedia. If the fund trades at a 10% discount to NAV, which is typical of closed-end funds, then that drops to $21.80, he said.

Even without accounting for a 2% annual fee, Ritter estimates that the the portfolio would have to outperform by roughly 13% for investors to break even. The S&P 500 returned about 16% last year.

The reason why private equity has until recently remained in the domain of the very wealthy or big institutions is because “the SEC has historically focused on investor protection,” Ritter said. “If you’re rich and you lose $100,000 you don’t worry about where your next meal is coming from.”