Structuring an Allocation to Private Equity

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Advisors may want to help clients take advantage of private equity investments for a variety of reasons, including the potential to enhance a portfolio’s return, manage risk, and improve diversification. Indeed, historical data has shown that expanding a traditional 60/40 portfolio to include an allocation to private equity may help build portfolio resiliency, adding a new source of diversification and potentially uncorrelated returns.

Yet for clients with the appropriate risk and liquidity profiles, advisors may wonder how to best implement a private equity allocation. How can they determine, for example, the appropriate percentage allocation and which part of an existing portfolio it should replace? Without understanding the role private equity can play and following a thoughtful process, it can be challenging for advisors to determine the most effective way to implement private equity alongside a client’s other investments.

Why allocate to private equity?

Investors and their advisors have become more open to allocations to private investments in recent years as they seek improved risk-adjusted returns and diversification benefits. Today, given the growing availability of low-minimum investment options, more investors have access to these strategies, once reserved for only the largest institutional investors.

While past performance is not a guarantee of future results, of course, historical data has consistently shown that adding an allocation to private equity investments can potentially help increase a portfolio’s Sharpe ratio. As a reminder, the Sharpe ratio is a measure of risk-adjusted excess return -- it measures the extent to which an investor has been rewarded for the level of risk they have taken in their investment. Further, the diversification benefits of private equity can potentially help client portfolios become more resilient in periods of market distress than portfolios invested solely in public securities.