The Institutions With the Biggest Allocations to Private Markets Outperform Their Peers

Over the last decade, larger allocations to private equity and venture capital resulted in higher returns on average, according to Cambridge Associates.

(Fredrik Solstad/Bloomberg)

(Fredrik Solstad/Bloomberg)

Institutions with larger shares of capital invested in private equity and venture capital earned higher returns in 2020, according to new research from Cambridge Associates.

In the past decade, those with a private investment allocation of at least 30 percent have outperformed those with an allocation of 10 percent or less by 200 basis points, the investment and consulting firm said.

Private equity and venture capital investments were also found to be more profitable than U.S. public equities over the last five, 15, and 25 years.

In the report, Cambridge Associations evaluated the performance of public equities by calculating the return of the S&P 500 index if shares were bought and sold on a schedule matching the cashflows of private funds. Measured this way, U.S. public equities have fallen behind their private peers by 250 to 320 basis points over the last five and 15 years.

The report attributed this performance gap to privately managed funds having more information advantages, as well as venture capital funds investing in companies targeting pressing issues like climate change, healthcare, and diversity. Some successful fund managers are also involved in the decision-making process by serving as advisors, board members, or majority owners of the companies they invest in.

But most importantly, VC and PE offer exposure to technology innovations, which have become a key to success for “nearly every business,” according to Cambridge Associates.

“The VC space can deliver investors awareness of, and access to, cutting-edge technologies,” the firm said in the report. “Having investment exposure to these emerging companies can provide insights into their impact on other asset classes and the dynamics of an evolving financial landscape.”

According to Mike Larsen, who oversees VC investments for endowments and families at Cambridge Associates, Covid-19 has accelerated companies’ adoption of technology, leading to a boom of cloud software solutions, future-of-work technology, and EdTech.

“Technology has been a principal driver of performance,” he told Institutional Investor.

While the report found that large allocations to PE and VC were correlated with higher returns, Cambridge Associates acknowledged that a large private investment allocation “may not translate into outperformance.” Liquidity, for example, can pose a challenge for institutional investors seeking high returns in private markets. Most investors have increased their private investment allocations at a pace greater than the growth of the size of their portfolio, causing an upward trend in uncalled capital commitments to private market funds.

Nonetheless, for institutional investors with a longer-term return horizon, “illiquidity can be a big return engine for a portfolio when used wisely and carefully,” Larsen said.

“Technology developments are likely to continue to transform the global economy,” the report concluded. “Investors properly positioned in private investments may have many more years to remember ahead.”