Barriers to high private equity allocations aren't as steep as many investors believe, according to Boston-based investment adviser Cambridge Associates.
Cambridge, which conducted a study called “The 15% Frontier” based on 453 university, college and foundation endowments, found that over half of the top ten, top quartile US private equity funds between 2004 and 2012 were new funds, meaning first- or second-time funds.
“[T]he view that private investing requires access to a very small group of tightly closed top-tier firms is a somewhat dated view of the private investment industry”, Cambridge president Philip Walton said in the report. “As it has grown and developed, new and developing venture capital funds have frequently appeared at the top of the lists of vintage year returns, often outperforming established funds”.
Cambridge said the three main objections to endowments raising their private allocation are illiquidity intolerance, the belief that large scale and resources are necessary to invest in private assets, and the perception of top-tier funds being limited to very few investors.
But many investors put a value on liquidity that's worth more than their actual needs, preventing them from allocate more to the illiquid private assets, Walton said in the report. He added that once investors conduct an analysis of their spending policy, cash needs for operations, debt services requirements, cash sources outside the long-term pool, and the availability of credit facilities, they'll realise that “a higher private investment allocation is well within their tolerance for illiquidity”.
Cambridge also found that investors do not need large portfolios with access to vast resources to allocate to private assets. There were 174 endowments in the group that allocated 15 percent or higher to private assets, and over a quarter of them (48) had assets under management of below $500 million. In that same pool, almost 15 percent of them (26) had AUM of below $250 million.
According to the report, some of those smaller endowments do find it challenging to invest in large funds with high minimum commitment sizes, but they have acknowledged that the benefits of investing in private assets outweigh the efforts put into build resources to do so.
The study found that those who allocated 15 percent or more of their portfolio to private investments had a higher return than all the endowments the researchers examined.
Private investments, including private equity, venture capital and distressed debt, returned a median of 3.6 percent for the fiscal year ended 30 June 2015, compared with just 1.3 percent median return realised by all endowments observed.
At the same time, the median private allocation among all endowments was just 10.7 percent.
And while the top-performing quartile of all endowments had an average private allocation of 24.1 percent for the 10-year period ended 30 June 2015, those in the bottom quartile had an average 6 percent allocation to the same assets, according to the report.