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Invest Like an Institution: Private Equity


You may have heard of the investment success of the Yale endowment under the direction of Chief Investment Officer, David Swensen (if not, Google him). Per the National Center for Education Statistics, Yale has the second largest US university endowment with over $29 billion in assets under management. Consider the following excerpt from the Yale Investments Office home page describing the endowment’s approach to asset allocation:


“Over the past 30 years, Yale dramatically reduced the Endowment's dependence on domestic marketable securities by reallocating assets to nontraditional asset classes. In 1988, nearly three quarters of the Endowment was committed to U.S. stocks, bonds, and cash. Today, domestic marketable securities account for less than one- tenth of the portfolio, while foreign equity, private equity, absolute return strategies, and real assets represent over nine-tenths of the Endowment.[1]


And it isn’t just Yale that is re-allocating assets away from public equities toward private markets. Blackrock’s 2019 Global Institutional Survey of 230 institutional clients representing $7 trillion in investable assets found that: “A significant portion of institutions intend to increase their exposure private markets: real assets (+54%), private equity (+47%) and real estate (+40%). This continues a multi-year structural trend of clients reallocating risk in search of uncorrelated sources of return.”[2]


Of the alternative asset classes mentioned above, I’d like to focus on private equity for the moment. For those who are not familiar, private equity is just what it sounds like - an investment in a privately-owned company. At a very basic level, private equity fund managers like KKR and The Carlyle Group (to pick on two of the largest) seek to buy a company, improve performance and, ideally, sell at a profit. Usually, the investors in private equity funds are institutions such as endowments, pension funds, insurance companies and foundations.


While individual investors have been largely sidelined in this market, studies have found that the average institution investing in alternative assets targets an allocation to private equity ranging from ~6% to 13% (~33% in the case of Yale).[3] So why are they so bullish on private equity?

  • Diversification – The number of US public companies has declined by ~50% over the past 20+ years to ~3,500 vs. ~5.95 million private companies as of 1Q19[4] – access to private equity expands the opportunity set of corporate investments, which increases portfolio diversification

  • Returns potential – The Cambridge Associates Private Equity Index generated a 5-year annualized return of 14.7% vs. 10.1% for the S&P 500[5]; furthermore, many analysts believe public equities are poised to generate lower returns with higher volatility after the record 10+ year expansion of the S&P

  • Market resilience – Private equity is somewhat insulated from public market swings and has demonstrated lower volatility than and lower correlation to public equities


Historically, individual investors have been unwilling and/or unable to invest in private equity due to lack of access, high investment thresholds (in the millions), illiquidity, and complexity of tax reporting, to name a few obstacles. However, in recent years, asset managers have started to partner with private equity firms to broaden access to this asset class for private clients at lower minimum investments (think $25-$50k). Other benefits of these funds include diversification by geography, strategy and vintage year, no capital calls, and 1099 tax reporting. While some funds offer limited quarterly liquidity to investors, this should still be an important consideration (among others) for anyone contemplating a private equity investment.


If you are interested in learning more about private equity and these types of access funds, please feel free to contact me. In the next installment of this multi-part series - Investing Like an Institution - I’ll explore incorporating private credit into investment portfolios. Stay tuned!

[1] Source: http://investments.yale.edu/

[2] Source: https://www.blackrock.com/institutions/en-us/insights/rebalancing-survey

[3] Sources: Cambridge Associates, eVestment Alliance, Prequin, Yale 2018 Endowment Report

[4] Sources: Wilshire 5000 Total Market Index as of 3/31/19; US Census Bureau 2016 Statistics of US Business Annual Data, released 12/18

[5] Source: Morningstar data as of 9/3/19

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