Alternative Investing

Demystifying Illiquid Assets: Expected Returns for Private Equity

Topics - Alternative Investing Asset Allocation

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Demystifying Illiquid Assets: Expected Returns for Private Equity

The growing interest in private equity means that allocators must carefully evaluate its risk and return. The challenge is that modeling private equity is not straightforward due to a lack of good quality data and artificially smooth returns. We try to demystify the subject, considering theoretical arguments, historical average returns, and forward-looking analysis. For institutional investors trying to calibrate their asset allocation decisions for private equity, we lay out a framework for expected returns, albeit one hampered by data limitations, that is based on a discounted cashflow framework similar to what we use for public stocks and bonds.

In particular, we attempt to assess private equity’s realized and estimated expected return edges over lower-cost public equity
counterparts. Our estimates display a decreasing trend over time, which does not seem to have slowed the institutional demand for private equity. We conjecture that this is due to investors’ preference for the return-smoothing properties of illiquid assets in general.

 

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The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of AQR Capital Management, LLC, its affiliates or its employees. This information is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein. Past performance is not a guarantee of future results.

 

Hypothetical performance results have many inherent limitations, some of which, but not all, are described herein. Hypothetical performance results are presented for illustrative purposes only.

 

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