Abstract

We study the impact of including private investment funds into diversified portfolios that otherwise hold only public stocks and bonds. Our analysis uses a large sample of 3,380 U.S. buyout, venture capital, and real estate funds to simulate portfolios from 1987 to 2018 that substitute part of the public equity allocation with private funds. We find that investing in private funds almost always increases average portfolio returns and reliably increases Sharpe ratios for portfolios with buyout and real estate funds. The results are robust to accounting for various practical considerations: higher costs of managing private assets, restrictions on the number of annual commitments, making only primary commitments, and the aggressiveness of building up to the target allocation. Our analysis allows for a better understanding of a variety of important characteristics of portfolios investing in illiquid private funds, including the range of possible performance outcomes, the deviation from target allocations over time, and the trade-offs between different
risk-return profiles. Finally, we document a very pronounced risk-return trade-off between portfolios with buyout, real-estate, and venture capital funds.