Nobel Prize-winning economist Harry Markowitz once called diversification “the only free lunch in finance”. Private equity has historically provided one of the most attractive…
Nobel Prize-winning economist Harry Markowitz once called diversification “the only free lunch in finance”.
Private equity has historically provided one of the most attractive risk-adjusted returns among asset classes. Hence, portfolios allocating to private equity have historically generated a greater return with similar risk to traditionally diversified portfolios.
The very basis of investment portfolios is to construct them with imperfectly correlated assets in order to take advantage of the principle of diversification. In recent research from 2017, Professors Dr. Doskeland and Strömberg from Norwegian School of Economics concluded that including private equity in a fund’s portfolio improved the fund’s capacity to optimize risk-adjusted returns, further alluding to the possibility that private equity’s role in global markets could enhance its diversification potential over time.
Given the current access to low fee and highly diversified public market portfolios through increasingly dominant index-based ETFs, we suspect that private equity represents the only remaining missing piece for individuals to access the “free lunch” of portfolio diversification.
Private equity’s capacity to focus on active ownership, operational and strategic improvement, as well as business transformation is a unique source of value creation, one that cannot be imitated in the public markets.
Private equity funds have a certain degree of diversification in their DNA, by definition investing into a variety of underlying companies.
This unique and diversified exposure forms the thesis for private equity’s prime position in the most successful institutional portfolios, such as the Yale Endowment, the largest US educational investment endowment.
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