Over the years, a number of alternative investments have become increasingly available to RIAs and their high-net-worth clientele. Hedge fund of funds burst into the scene about 15 years ago, followed by mutual funds that utilize a plethora of market neutral strategies. Private equity may well be the next piece of the alternative puzzle to approach mainstream status.
Most of the large private equity firms specialize in taking public companies private. This transition is highly attractive to executives, as it frees them of the strains of Sarbanes Oxley and allows them to spend all of their time concentrating on a "good to great" transition. Once the company is on better financial footing, they are typically sold via IPO into the capital markets once again, with the hope of enriching private equity investors in the process.
In return for tying up their limited partner's cash for ten years, the return of the asset class includes an "illiquidity premium" that typically vaults returns 8%-10% over the stock market; as a result, investors should expect to earn this premium, plus the return of the equity markets, for the life of their commitment.
Fortunately, this premium is uncorrelated to the returns of either stocks or bonds; as a result, adding private equity can potentially both reduce the risk (as measured by standard deviation) and increase the return of a traditional portfolio composed of equity and fixed income.
