Integrating Private Equity in a Liquid Multi-Asset Portfolio

Abstract

In this article, the authors define a comprehensive, rigorous and intuitive portfolio construction framework that accounts for the key aspects of private equity investing in multi-asset portfolios. These aspects are normally ignored in more conventional asset allocation approaches such as mean–variance, mainly because there are no readily available approaches that can handle the distinct assumptions of illiquid assets. In particular, the framework accounts for the illiquid feature of private equity, as well as for its cash flow features, and highlights how these fit together for constructing multi-asset portfolios with other traditional asset classes. Also, because private equity is a form of active investing, by building on previous research, the authors provide an approach that allows integrating active preferences into the asset allocation decision and accounting for active and passive risk–return trade-offs.