Private Equity Becoming a Beta Asset Class

A new study of the private equity market finds that securitization - bundled funds of publicly traded private equity firms - is changing the private equity asset class.

An Ibbotson Associates news release about its research said that over time, what was once an alpha, skill-based strategy is becoming a traditional beta asset class.

According to the announcement, Ibbotson Associates relied on two new indexes of publicly traded private equity firms to represent the private equity asset class—the Red Rocks Listed Private Equity Index for U.S. private equity and the Red Rocks International Listed Private Equity Index for non-U.S. private equity. Researchers found that weighting scheme plays a big role when it comes to performance.

The domestic private equity compound annual return ranged from 4.5% to 24.9% from 1997 – 2006 depending on weighting scheme of the index, and the compound annual return for the international private equity ranged from 10.8% – 21.5%, compared to 8.6% for the S&P 500 over the same period.

When it comes to historical optimizations, the research found that adding even the most pessimistic historical domestic and international private equity Indexes to the opportunity set increased the risk/return tradeoff in the portfolio with optimal allocations ranging from 0 – 7% and an average improved return of 46 basis points. At the optimistic end, an unconstrained optimization with domestic and international private equity improved average returns by 633 basis points, the Ibbotson researchers found.

The study said traditionally, investors would allocate to a skill-based strategy in either leveraged buyouts or venture capital. The fragmented structure of the private equity market was such that private equity investors could not fully diversify away from private company specific risk. So, all private equity investments were a mixture of systematic risk exposure to the private equity asset class and to private company specific risk, the study said.

The study was conducted by Thomas Idzorek, vice president and director of research and product development for Ibbotson. The report is available here.