Generating Superior Performance in Private Equity: A New Investment Methodology

Abstract

This paper provides a new investment methodology for private equity portfolios that applies principles of investment management used in traditional asset classes. We apply Modern Portfolio Theory (MPT) with rational selection of portfolios that are on the efficient frontier of risk-reward optimality, to back-test the performance of private equity (PE) investment portfolios against a corresponding sub-portfolio that is closer to the efficient frontier. The methodology is a guide for investors to build PE portfolios designed to generate superior performance; our experiments show that it is possible to get a performance improvement as large as 20% in some public pension fund portfolios.

Keywords: Private equity, fund performance, efficient frontier, portfolio theory

JEL Classification: G00