The Components of Private Equity Performance: Implications for Portfolio Choice

Posted: 7 Mar 2014

See all articles by William B. Kinlaw

William B. Kinlaw

State Street Global Exchange

Mark Kritzman

Windham Capital Management

Jason Mao

State Street Corporate

Date Written: February 28, 2014

Abstract

We use a proprietary database of private equity returns to measure the excess return of private equity over public equity and to partition it into two components: an asset class alpha and compensation for illiquidity. Our evidence suggests that private equity managers, as a group, generate alpha by anticipating the relative performance of economic sectors. If we assume that manager‐specific alpha is fully diluted across a broad universe of private equity managers, we can interpret the balance of excess return as a premium for illiquidity. This result suggests that investors can capture the asset class alpha of private equity by using liquid assets such as ETFs to match the sector weights of private equity investors. This decomposition of private equity performance has important implications for portfolio choice, which we explore in this paper.

Keywords: Asset class alpha, Excess return, First mover advantage, Illiquidity premium, Lock up, Pseudo private equity, Risk-equivalent return, Shadow allocation, Shadow asset, Shadow liability, Stepwise regression

JEL Classification: G11, G12

Suggested Citation

Kinlaw, William B. and Kritzman, Mark and Mao, Jason, The Components of Private Equity Performance: Implications for Portfolio Choice (February 28, 2014). MIT Sloan Research Paper No. 5084-14. Available at SSRN: https://ssrn.com/abstract=2404612 or http://dx.doi.org/10.2139/ssrn.2404612

William B. Kinlaw (Contact Author)

State Street Global Exchange ( email )

One Lincoln Street
Boston, MA 02111-2900
United States

Mark Kritzman

Windham Capital Management ( email )

5 Revere Street
Cambridge, MA 02138
United States
617-576-7360 (Phone)
617-576-7359 (Fax)

Jason Mao

State Street Corporate ( email )

1 Lincoln Street
Boston, MA 02111
United States

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