For several decades, private equity has been a mainstay investment for institutions, endowments and high net-worth individuals as it has provided better returns versus traditional equity investments over long time horizons. Institutions typically use private equity as a potential “return enhancer” and allocate 7 percent - 10 percent of their entire portfolio to the private equity asset class, according to the 2013 NACUBO Commondfund Study of Endowments. As institutions have long investment horizons, they have developed approaches to managing the illiquidity of traditional private equity.

Since 2000, a number of U.S. private equity firms have gone public and broadened their investor base as advisors and retail investors have sought to replicate the historical returns of private equity in their portfolios. In Europe and other parts of the world, where the listed private equity model is more common, there are hundreds of public-owned private equity vehicles, many of which have been available for decades. These listed companies provide non-accredited investors access to private equity returns without such usual investor challenges as huge investment minimums, long lock-up periods and extensive due diligence requirements.

Red Rocks Capital estimates the investable universe of listed private equity is made up of more than 350 firms and $300+ billion in market value globally. According to Preqin, a data provider that tracks alternative investments, global private equity AUM is $3.5 trillion, or over half the global total alternative investment AUM of $6 trillion.  In short, we believe there is a significant universe of quality private equity firms that provide direct private equity exposure in a liquid structure.

Alternative Have Not Kept Race With Broad Markets
Although alternative strategies showed initial promise in enhancing portfolios, the past five years have been a challenge for advisors, as many alternative strategies have not kept pace with the overall market. As illustrated in the chart below, the S&P 500 has averaged almost 23 percent per year. While the Red Rocks Capital Global Listed Private Equity (GLPE) index has averaged over 33 percent per year, the Credit Suisse Hedge Fund index has had average returns of 8.75 percent per year over the past five years.

Many institutions pair private equity investments with their alternative investments to provide alpha and offset some of the performance drag of hedge funds and other alternative strategies.  Advisors are looking for additional tools and strategies to capture more upside for their alternative investments; listed private equity could be one tool to enhance their portfolios. 

Retail Allocations To Private Equity Significantly Lag Institutional Portfolios

Barron’s recently published an article highlighting an advisor study that illustrated client portfolio allocations of 40 of the top wealth managers. As illustrated in Table 1 below, the average allocations to alternative investments was 20.4 percent with over half of that allocated to hedge fund strategies. The median allocation to private equity in this study was 2.75 percent, while 40 percent of advisors allocate 0% to private equity. Of the 60 percent of advisors who did allocate to private equity, the average allocation was 5.5 percent, with a range of 1 percent to 14 percent. Other studies of retail allocations, such as the 2012 McKinsey The Mainstreaming of Alternative Investments report similar alternative strategy allocations.


 

Potential Benefits Of Allocating To Private Equity
To illustrate potential investor benefits from allocating to private equity, we built two hypothetical portfolios. Portfolio A consists of 50 percent equities, represented by the S&P 500 Total Return Index, 30 percent bonds, represented by the Barclays Aggregate Bond Index and 20 percent hedge fund strategies, represented by the Credit Suisse Hedge Fund index. Portfolio B consists of 40 percent equities, 30 percent bonds, 20 percent hedge fund strategies and 10 percent private equity, represented by the Global Listed Private Equity (GLPE) index. Both portfolios were rebalanced quarterly to original allocations.



 

Over the past five years, Portfolio A has returned 14.27 percent with a portfolio beta of 0.52. After allocating 10 percent of the portfolio from equities to private equity, Portfolio B returned 15.45 percent with a portfolio beta of 0.57.  Portfolio B, with only a 10 percent allocation to private equity, provided 1.18 percentage points in additional returns per year while marginally increasing portfolio beta.


 

Conclusions
Although alternative strategies can provide diversification and risk-reduction benefits, many of these strategies underperform in rising markets. Advisors face a dilemma of how to provide for additional performance in their alternative allocations while managing risk for their clients.

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