Diversifying Private Equity

Posted: 18 Feb 2020 Last revised: 26 Mar 2024

See all articles by Oleg Gredil

Oleg Gredil

Tulane University - A.B. Freeman School of Business

Yan Liu

Purdue University

Berk A. Sensoy

Vanderbilt University - Finance

Date Written: Fabuary 3, 2020

Abstract

Most institutional investors in private equity (PE) invest in one or two PE funds per year. We propose an expected utility framework to account for the resulting lack of diversification. For a typical investor, certainty equivalent returns from PE investing are about 5% lower than if inferred from average fund performance. Chasing PE managers with high past performance increases idiosyncratic risk, which for most investors outweighs improvements in expected return. Funds-of-funds can create value through diversification even with average performance. Investors encountering negative performance shocks diversify more over time, consistent with learning about the risks of underdiversification.

Keywords: Private Equity, Venture Capital, Fund of Funds, Fund Performance, Portfolio Choice

JEL Classification: C11, D83, G11, G23, G24

Suggested Citation

Gredil, Oleg and Liu, Yan and Sensoy, Berk A., Diversifying Private Equity (Fabuary 3, 2020). Available at SSRN: https://ssrn.com/abstract=3535677 or http://dx.doi.org/10.2139/ssrn.3535677

Oleg Gredil (Contact Author)

Tulane University - A.B. Freeman School of Business ( email )

7 McAlister Drive
New Orleans, LA 70118
United States

Yan Liu

Purdue University ( email )

West Lafayette, IN 47907-1310
United States

HOME PAGE: http://yliu1.com

Berk A. Sensoy

Vanderbilt University - Finance ( email )

401 21st Avenue South
Nashville, TN 37203
United States

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