Why private equity can be a good addition to your portfolio

What is private equity?

Private equity is a trillion-dollar investment class that comes under alternative investments (or alts, for short). Private equity (commonly known as PE), prefers to shares or ownership in any company that is not publicly traded on a stock exchange. It tends to be illiquid and is thus suitable for a longer-term investment horizon. In contrast, public equity investments can be traded daily.

Within private equity, buyout strategies often invest in bigger and more mature companies with a proven financial record, while venture capital (VC) strategues typically go to young or early-stage businesses with the potential for fast growth.

How does private equity investing work?

Historically, most of the PE capital comes from institutional investors such as pension and endowment funds. Investors can access the asset class in several ways, including investing directly in the private company, or through funds, co-investments, or separately managed accounts.

The pooled fund structure, in particular, is widely used. A private equity fund is known as a limited partnership, and investors who contribute to it are the limited partners (LPs). Investment professionals from the PE firm that created the fund are the general partners (GPs), and they will manage the investments.

After forming the fund, the firm puts out a call for investors to pool their money, which will be used to invest in private companies according to a specific investment strategy and approach.

Usually, the goal of a PE fund is to sell its stakes in the portfolio companies for a high return on equity at an opportune time. There are different investment strategies a fund can adopt to attain this goal, and every fund will have a particular return target.

Under a buyout strategy, the fund takes a controlling interest and finds ways to build value, such as by organically expanding its business or improving an underperforming unit. In buyouts, PE investors will be focused on the product, business plan, and quality of the target company’s management — they may even recruit a new management team to run it.

PE investors often aim to add value to the target company, to maximise profits when their shares are sold. 

Why invest in private equity?

Investors looking for higher return potential and further diversification can consider adding private equity to their portfolios.

PE has the potential to increase the overall portfolio return. Historical data shows private equity funds offered attractive returns, when compared to traditional assets like public equity and even other alternatives. 

Moreover, private equity helps to diversify your portfolio by mitigating both public market risk and cyclical risk. Diversification is best achieved when the investment portfolio is built with assets that are not perfectly correlated.

PE funds’ returns have a lower correlation with public markets. Although broader economic conditions might have an impact on each portfolio company’s performance at a fundamental level, PE fund managers work to create value over the long run, seek out long-term returns. 

That stands in contrast with the public markets, which are highly liquid and may see many investors speculating and trying to time the market by trading frequently.

Also, private equity funds usually invest in a variety of companies, giving the LPs access to different sectors and geographies.

Data shows that in times of stress or public equity underperformance, investors allocate even more to private markets.

Private equity in a downturn: resilient and diversified

Historically, private equity has outperformed public equity throughout the boom and bust market cycles.

A report by Neuberger Berman that analysed the major economic downturn of the early 2000s, the 2007-2009 global financial crisis, and the 2020 Covid-related market events, found that private equity historically experienced a less significant drawdown and a quicker recovery than public equities in all such instances.

The resilience reflected both the greater insulation from public market sentiment and the amount of active control that private equity investors have over portfolio companies.

Private equity proved particularly resilient during the Global Financial Crisis, noted by some as the first real test for the investment class. Data from Preqin shows that the S&P 500 was hit by a maximum drawdown of some 40% between 2008 and 2009. Private equity, however, as measured by the Preqin Private Equity Quarterly Index (PrEQIn) was down by just 26.6%.

How to build a diversified portfolio with private equity

Many individuals stick with the public markets and maintain the classic 60/40 mix of assets (60% stocks and 40% bonds). This portfolio construction is guided by the idea that equities and fixed income usually don’t move in tandem, therefore when stocks perform poorly, bonds may offset some of the losses and provide income.

However, the turbulent and uncertain markets during Covid in 2022 have shown that traditional fixed income may not always serve as a shock absorber in a portfolio, and both stocks and bonds logged unprecedented double digit losses that year.

With this in mind, investors may wish to introduce private equity to diversify the stocks component of their portfolio, be it within a 60/40 mix or another asset allocation strategy, to ride out the volatility and benefit from the liquidity premium. 

Larry Fink, the Chairman and CEO of BlackRock, the largest asset manager in the world, touted a suggested allocation of 50-30-20 for individual investors (50% stocks, 30% bonds and 20% private assets) in his 2025 Annual Letter to Shareholders, citing benefits of diversification, less volatility, protection against inflation and higher returns potential.

With that said, before investing in PE, consider if you are comfortable with the investment strategy and whether it fits your objectives. This will determine whether you should consider a buyout fund that aims to add value to a mature company, versus a growth equity fund that looks for rapid growth and may take on minority stakes, for instance. 

Investors can also choose funds with a specific sector or geographical focus that differs from their existing allocations, to diversify their current portfolios.

What are the risks involved in private equity?

Private equity carries additional risks due to the illiquidity of the underlying assets. Traditionally private equity is only available via close-end funds with long lock-up periods, during which the GP can use the capital for the value-creation initiatives at the portfolio companies. Investors will not be able to liquidate their positions for up to 7 to 10 years.

The emergence of semi-liquid, "evergreeen" funds solves for this issue, allowing individual investors to get some levels of liquidity if required, although with gate restrictions typically 5 to 10% of the fund in a given quarter.

Private comapnies are also subject to less regulatory oversight and do not need to follow strict reporting requirements, unlike public companies. Due diligence is therefore crucial to evaluate all investment opportunities, minimise risks, decide which deals are worth pursuing, and set a suitable purchase price. Many PE firms have substantial research and due diligence teams to assess the financial, legal, and management situations at prospective target companies.

Debt or leverage is often used to finance PE investments. This allows a fund to put down smaller sums of cash and get greater gains if it sells at a profit. To be sure, it also means the risk of loss is significant if the investment fails.

In general, alternative investments are complex and suitable only for investors with sufficient knowledge and experience to understand the risks involved.

Start your private equity investing journey with Endowus

Private equity can play an important role in a long-term, diversified, multi-asset portfolio for disciplined investors.

Investors should give careful consideration to their overall portfolio strategy — including their risk tolerance, cash flow needs, and liquidity constraints — before adding any new assets to their portfolios.

Endowus offers exclusive access to private equity strategies with global alternative investment giants including Blackstone, Carlyle, CVC, EQT, HarbourVest, Partners Group and more.

We have worked with fund manager partners to lower the typically high investment minimum of these strategies, and do not charge subscription or redemption fees.

If you are not yet a Professional Investor, opt-in today and to unveil private equity and other leading alternative strategies. Contact us for a consultation. or email us at privatewealth.hk@endowus.com if you have any questions.

Click here to get started on Endowus, and a better way to manage your wealth.

Read more:

• How to allocate across private equity, private debt and hedge funds?
• How alternative investments can fit into one's portfolio
• Learn about HarbourVest Partners and private equity secondaries

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