For decades, the 60/40 portfolio (a mix of 60% equities and 40% bonds) was the foundation of a typical asset allocation. It provided a balance of growth and stability, ensuring long term resilience. But the challenging and volatile economic environment over the last decade has led more wealth managers and investors to reconsider their allocations. The once reliable hedge of fixed income is no longer delivering the same level of protection, pushing investors to explore alternative assets that can provide stronger returns, diversification, and a potential cushion against economic shocks.
Among the range of available alternatives, private equity has emerged as a popular pillar in modern portfolio construction, complementing the traditional investments at its core. Its potential for higher long-term gains, exposure to emerging high-growth businesses in vibrant sectors and insulation from short-term market fluctuations are increasingly appealing to private investors.
The potential limitations of the 60/40 model became stark in 2022 when both asset classes declined simultaneously, which was the first time since 1977 that both equities and bonds had generated negative returns in the same year. This contradicted the traditional assumption that negative performance in one of the asset classes would be offset by positive performance in the other, diminishing the expected diversification effect. Whilst this has rebalanced itself to a degree recently, inflation is expected to remain sticky and alternatives’ low correlation to traditional assets is a sought-after characteristic. For over a decade public market indices have also become more concentrated. The London Stock Exchange has been afflicted in recent years by delistings and high profile companies deciding to stay private. Meanwhile, in the US the five largest stocks in the S&P500 now account for approximately 20% of the index’s total market capitalisation.
In response, more individual investors have begun to follow their institutional counterparts, who have been highly active in alternatives for many years, by gaining exposure or increasing existing allocations to private equity. A report by Preqin shows that institutional allocations to private equity have grown steadily over the past decade, with a growing number of private investors following suit. Unlike public equities, private equity investments are not affected by daily market fluctuations, making them a powerful tool for reducing overall portfolio volatility. According to Modern Portfolio Theory, allocating between 10% and 30% of a portfolio to private equity and other alternative assets can enhance diversification and the potential for higher risk adjusted returns.
Private equity’s appeal is largely driven by its ability to outperform public markets over extended periods. Research by McKinsey has consistently shown that private equity funds generate higher long-term returns than traditional equities, a trend largely attributed to the active management strategies employed by private equity firms. Unlike publicly traded companies, which are often under pressure to meet quarterly earnings expectations, private equity backed businesses benefit from a more strategic, long term approach. Investment managers work closely with portfolio companies, implementing operational improvements, restructuring inefficiencies, and driving growth strategies that might not be feasible under public market scrutiny as short term results are demanded.
This hands-on involvement, combined with access to businesses at various stages of growth, gives private equity investors exposure to opportunities that public market investors simply cannot access. Start-ups, early stage companies, and firms undergoing transformative change often seek private capital before considering a public listing, and private equity investors can capitalise on this early stage growth potential.
The increasing dominance of technology investments in private equity portfolios is a testament to this, with software, SaaS models, and AI-driven companies attracting significant private capital due to their scalability and profitability. A Bain & Company report highlights that technology deals now represent a substantial share of private equity investments, reinforcing the sector’s long-term potential.
The same pattern can also be seen with established later-stage companies. According to research by Hamilton Lane, 87% of US companies with annual revenues exceeding $100 million are private, meaning investors solely focused on public markets are not getting access to where the bulk of innovation and dynamism is happening. Accessing fast-growing businesses through listed equities is simply becoming harder. Adding private market exposure can provide access to some of the UK’s most exciting companies.
*Source: Hamilton Lane and Capital IQ, 2022
This shift is being facilitated by an increasing range of investment structures and revised regulations that widen access. Private equity funds remain a popular choice for institutional and professional investors seeking exposure to a professionally managed portfolio of private companies. These funds offer diversification across sectors and stages, as well as the benefit of experienced investment teams handling sourcing, due diligence, and portfolio management.
However, a growing number of investors are seeking even greater control and flexibility by co-investing deal by deal alongside private equity firms. This approach allows them to self-select investments that align with their risk appetite and sector preferences. Deal by deal co-investment, such as Maven Investor Partners, enables smaller amounts to be invested at the time that each deal is completed, rather than the traditional pooled fund model where an amount is committed up front and then drawn down over the investment period as the manager makes the underlying investments.
Whether through diversified funds or direct deal participation, experienced investors are leveraging these methods to build more resilient, high growth portfolios beyond the constraints of the traditional asset allocation model.
Innovative fund structures like Long Term Asset Funds (LTAFs) are slowly opening the door for retail investors to access long term private market investments too, but as this instrument is relatively new and there is an acute lack of product availability to date, mass uptake will take time.
Private equity investment trusts provide retail investors with another avenue to access this attractive asset class. Their performance has been impressive, with a 10-year track record delivering an average return of over 300% compared to an 87% return for the FTSE 100 over the same period according to data from Investec.
*Source: FT Adviser, 2023
Private equity sits alongside a range of other alternative asset classes, including the likes of private credit and real estate, each with their own unique characteristics. It is important that alternatives are not viewed as a single, all-encompassing asset class. Each has its distinct strategy with different drivers and risk/return profiles. The decision to invest in one of over the other will ultimately come down to an investor's objectives, risk tolerance, liquidity needs, and time horizon.
Private credit has the potential to generate steady income, particularly in a higher interest economy, but it does not possess the long term growth upside of private equity. Real estate can provide tangible ownership of an asset which can give some downside protection, but it is heavily influenced by macroeconomic factors such as interest rates and regional market cycles.
Private equity stands out for many because of one fundamental reason – active portfolio management. It is this ability to drive value creation and enhance the value of portfolio companies that is, more often than not, behind private equity’s higher rates of return. Public markets are heavily analysed, leaving little hidden value. This is not the same for private markets, where skilled investors are able to identify overlooked opportunities and drive growth. In addition, private equity firms have proven that they are adept at finding investment opportunities where a business hasn’t been aggressively managed (i.e. a lifestyle business) and so is likely to be underperforming, or where a business is undervalued as its full growth potential has not been fully recognised.
Historically, private equity was primarily the domain of institutional investors such as pension funds and sovereign wealth funds. However, this is changing as wealth managers increasingly agree on the merits that alternative investments can provide and are increasingly incorporating them into their client portfolios. The expansion of private equity access through feeder funds, co-investment opportunities, and secondaries markets has allowed experienced and professional investors to participate in an asset class that was once beyond their reach. A study by Deloitte suggests that private investors are allocating a growing share of their portfolios to private markets, recognising the long-term value creation potential that private equity offers.
Wealth managers are now structuring portfolios to include private equity not just as a high-risk, high-reward allocation, but as a core component of a diversified investment strategy. This shift is particularly notable among family offices, which are increasingly favouring private equity for its ability to preserve and grow wealth across generations.
While private equity presents a compelling opportunity, investors must carefully consider its challenges. Liquidity remains the primary constraint, as capital is typically locked up for extended periods. Unlike publicly traded stocks, private equity holdings cannot be easily sold, requiring investors to have a clear understanding of their investment horizon before committing.
Another key consideration is cost. Private equity funds often come with higher management fees and performance-based carry structures, which can erode returns if not carefully assessed. Transparency and due diligence are essential when selecting private equity managers, as the quality of execution can significantly impact long-term outcomes.
Given the longer-term, illiquid nature of private equity investments, investors must adopt a different mindset and have disciplined cash management to ensure sufficient liquidity for potential cash flow needs.
Looking ahead, many analysts believe that the UK economy will not return to the ultra-low inflation and interest rates that were experienced before COVID - at least not any time soon. As a result, the negative correlation between stocks and bonds will not be as pronounced as it was in years leading up to 2020. A multi-asset portfolio will likely take on a different shape to the traditional 60/40 split with alternatives increasingly becoming a staple diversifier of a modern portfolio.
Open-ended structures and innovative investment platforms will continue to revolutionise the way private clients can access and invest in private markets. These developments are playing an important role in democratising private market assets, offering greater access to a wider pool of investors at potentially lower entry points.
According to Professional Wealth Management the asset class will become a key battleground for wealth managers as demand from clients for alternatives increases. By developing an alternatives offering, this will likely provide a competitive advantage and an improved client value proposition.
It takes time to fully build out an allocation in private equity either through deal by deal, where it may take an investor a number of years to construct their own bespoke portfolio, or through fund investment, where investors ideally do not want to put all their capital to a single vintage to reduce risk and increase diversification. Yet, with its broader investment scope compared to public markets, potential for higher returns, diversification benefits and the new macro regime, private equity is attracting increasing levels of non-institutional capital in the search for alpha.
As market dynamics shift and traditional investment models become less impactful, investors who stay agile and embrace private equity’s potential for long-term value creation and diversification may be better positioned to benefit from the next era of growth and innovation.