Including private equity in a portfolio can have powerful diversification benefits, which we covered in section Why invest in private equity?. Seasoned investors will appreciate the level of thought and analysis that goes into selecting which assets to include in a portfolio, and then rebalancing asset classes periodically to ensure that the portfolio remains close to its intended asset mix.
Here, we cover the process of evaluating your portfolio and selecting which PE fund style might best suit those needs. Then, we look at how you might take a top-down approach to selecting a strategy and a bottom-up approach to manager selection, before finishing with key elements of monitoring and rebalancing.
Much of this will be familiar to experienced investors, but there are critical differences between how private equity and traditional assets behave in a portfolio, so it’s worth going through the process systematically. For simplicity, we will assume that you are managing your own portfolio and purchasing either a primary or secondary investment in a fund managed by a General Partner.
Before you include a new asset in your portfolio, it’s necessary to have a clear picture of what overall strategy you’re aiming for and what your immediate objectives are.
Moonfare's portfolio funds are ideal for anyone looking for immediate diversification with a single investment.
With your overall strategy and needs in mind, consider your portfolio as it is now compared to how you want it to be. This guides your asset selection going forward, with the goal of optimising diversification to meet your strategic goals.
Use the answers to these questions to define your immediate objectives and determine the benefits and risks of adding a new asset to the portfolio. You should return to this step periodically to rebalance your portfolio and ensure that your objectives are still being met.
Your overall allocation to private equity should balance your strategic objectives in the context of factors such as:
Learn more about Private equity asset allocation on our detailed guide.
Since there are only a handful of unique strategies employed by PE managers, a top-down approach could be a practical way to identify the type of strategy that would offer a strategic complement to your existing assets. A portfolio with a heavy weighting in small-cap equities, for example, might steer toward buyouts or infrastructure PE funds rather than venture and growth funds.
Once you’ve settled on a preferred fund strategy, you might also consider regions, fund vintages, and other factors that might distinguish funds of a particular strategy type. You will also want to consider whether you expect to carry multiple fund stakes at a time or build a PE allocation that perpetuates itself by rolling distributions from one fund into commitments at others. Read our article about Private Equity Investment Strategies to learn more about selecting the right investing strategy that aligns with your objectives.
Once you have determined the private equity strategy that fits best in your portfolio, you are then in a position to evaluate fund managers who specialise in that type of fund strategy.
Fund Manager due diligence will focus on the entire management team and their affiliation with a well-known PE firm. It should consider their experience, strategy expertise, and track record in PE funds.
Monitoring and rebalancing assets within a larger portfolio are important to long-term performance. With private equity funds, investors monitor their holdings using quarterly valuations issued by the fund’s General Partner and through metrics such as the Multiple to paid-in capital (MOIC) or Total Value to Paid-in Capital (TVPI).
The GP handles the monitoring and rebalancing of assets within the fund, allocating capital as they see fit in accordance with the fund’s strategy and determining the optimal time to enter and exit company shares. This, in turn, is passed on by investors through capital calls in the early life of a fund and later through distributions as assets are liquidated.
PE fund investors are also familiar with the “J-curve” characteristics of PE fund returns, where initial valuations dip slightly negative as money is invested directly into company operations and then exhibit accelerated growth in later years as the companies reap the benefits of those earlier investments.
Our article on Portfolio Monitoring and Optimization discusses ways to keep your investment portfolio dynamic to better align with your objectives.
Important notice: This content is for informational purposes only. Moonfare does not provide investment advice. You should not construe any information or other material provided as legal, tax, investment, financial, or other advice. If you are unsure about anything, you should seek financial advice from an authorised advisor. Past performance is not a reliable guide to future returns. Don’t invest unless you’re prepared to lose all the money you invest. Private equity is a high-risk investment and you are unlikely to be protected if something goes wrong. Subject to eligibility. Please see https://www.moonfare.com/disclaimers.