Portfolio Design: A Modern Approach to Asset Allocation

KEY FEATURES OF PRIVATE EQUITY

Venture capital and buyout funds offer wealthy investors privileged access to investments that are unavailable to the general public. Presumably this privileged access brings superior returns to those institutions and families willing to put up with the illiquidity of these investments. This chapter has shown that the returns earned by these funds are on average superior to those on public equities. The measured returns are upwardly biased, but it’s difficult to know the size of this bias.

Regardless of the level of average returns, they are variable over time. In the 1990s, VC funds made enormous excess returns as a booming IPO market boosted the valuations of tech firms. Since that time, returns on VC have disappointed most investors. In the meantime, buyout firms soared as credit conditions became ideal for leveraged buyouts. Now that credit conditions have tightened, buyouts will be less profitable. Investors in this space must become used to wide pendulum swings.

Both types of funds have handsome payment structures for the general partners. Evidence suggests that some of these general partners provide persistent returns for investors. If returns are persistent, then access to the superior funds is an important challenge for investors. It’s probably safe to say that the investors who have been in this space for decades have preferred access over other investors.

NOTES

1. This description is based on Metrick (2007), Chapter 1.

2. Sometimes the ...