Diversifying Private Equity
51 Pages Posted: 18 Feb 2020 Last revised: 8 Jan 2021
Date Written: Fabuary 3, 2020
Uncertainty about manager skill and diversification constraints are hallmarks of investing in alternative assets. This paper quantifies the utility losses to private equity investors arising from these frictions. When calibrated to the data on institutional allocations to private equity and across-fund diversification, our analysis reveals that certainty equivalent returns in PE fund investing are 2-to-8\% lower than if inferred from average fund performance levels. Funds-of-funds can alleviate diversification constraints at the cost of fees-on-fees, and may be worth it for small, constrained investors. Chasing managers with high past performance entails high under-diversification costs that outweigh the benefits for most investors.
Keywords: Private Equity, Venture Capital, Fund of Funds, Fund Performance, Portfolio Choice
JEL Classification: C11, D83, G11, G23, G24
Suggested Citation: Suggested Citation