The role of private equity investments in investors’ portfolios has evolved over the past decade. Although the asset class was largely regarded as a niche allocation a few years ago, investors are increasingly looking at it as a way to enhance returns and access a unique opportunity set not available through listed markets.
These singular features have become more relevant today. Return expectations for almost all asset classes, and for bonds in particular, have fallen in recent years, as reflected in our lower capital market assumptions today versus a few years ago. As a result, constructing portfolios with satisfying returns has become a challenge for most asset allocators, especially for those with long-term liabilities (e.g., pension funds).
One way to address this issue is to consider allocating to private equity investments. Historically these have outperformed public listed equity investments. Going forward, we expect portfolios that include private equity to provide a higher return than traditional portfolios (Fig. 1).
Incorporating illiquidity in investor portfolios
Given the challenges associated with the asset class, allocating to private equity—and illiquid assets more generally—requires careful planning. To identify the appropriate allocation, investors first need to assess their willingness to invest for the long term, their tolerance for illiquidity, and their capacity to fund current and future expenses without touching their private equity allocation. By addressing these questions, investors can be better prepared to incorporate illiquid investments into their portfolios. In particular, investors should consider:
