Constructing optimized private equity programs

While primary fund commitments still make up the core of most private equity allocations, opportunistic strategies such as secondaries and co-investments now enable investors to craft investment programs more fully matched to their needs. We examine the application and benefits of this fuller toolkit.

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An expanded toolkit

As a result of the growth of private markets, there is an increasing need to take a more holistic and analytical approach in building private market portfolios, benefitting from the various investment types available and differentiating between more alpha oriented strategies in private markets.

For most institutional investors, primary fund commitments form the fundamental component of a well-planned, scalable and diversified private equity program. Opportunistic strategies such as secondaries and co-investments are derived from primaries and now provide a more nuanced approach to construct a private equity program. We focus on these investment types within the private equity market, although we will also touch on the blurring of lines between private equity and other asset classes, as well as overlaps between these investment types.

We highlight the benefits of both secondaries and co-investments in a broader private equity portfolio and perform quantitative analyses to examine how these investment types impact performance, pacing, J-curve mitigation and risk-reward characteristics.

Complementary profiles

Cumulative net cash flows over time for three transaction types

Cumulative net cash flows over time for three transaction types

Source: Obtained through Monte-Carlo simulation: All analyses are based on diversified private equity programs investing evenly and equally during four years in primaries, secondaries and co-investments. All programs are constructed in a random manner by sampling, without replacement, from a large universe of existing investments of which the full cash flow and historical valuations were available. Cash flows of underlying investments are aggregated to a program level and then aggregated to calculate the program IRR and TVPI, net of all management fees and carried interest at underlying and at provider level. In total, 10,000 simuation runs were performed. Results are representative for investors in these programs, not in individual investments or transactions

We find that a balanced, thoughtfully constructed program of primaries, secondaries and co-investments offers clear synergies and has the potential to deliver superior risk-adjusted returns beyond what each of the three transaction types can achieve in isolation. Moreover, we show how using these investment types, combined with different geographic exposures and other investment strategies, can enable investors to consider an efficient frontier in private equity. This frontier is a valuable tool to consider aggregate exposure to private and public equity – allowing investors to take a holistic view of their allocations across the equity spectrum. Ultimately, each investor has their own objectives, hence the optimal mix across transaction types, strategies and geographies will depend on those objectives.

Key takeaways

  • This paper lays out the differences between diversified private equity programs investing in primaries, secondaries and co-investments and analyses important investor outcomes such as J-curve, pacing, out-of-pocket exposure and incremental alpha.
  • We show that by varying transaction types, geographic exposure and investment strategies one can build portfolios with different characteristics across risk-target, return-target, duration, and economic risk factor exposures.
  • Ultimately, each investor has their own objectives – a large public pension scheme will likely have different objectives than a re-insurance firm. Hence the optimal mix across transaction types, strategies and geographies will depend on those objectives and this work attempts to provide insights into how these components can work together.

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Jeroen Cornel
BlackRock Private Equity Partners
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Julia Wittlin
BlackRock Private Equity Partners
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