The Magic Number in Private Investments

An allocation of 15% or more to private assets can be the difference between outperformance and negative returns, argues Cambridge Associates.

To truly reap the rewards of private investments, funds may need to hike up their strategic allocations.

An allocation of 15% or more to private assets is what separates the “very top” performers from the rest of institutional investors, argued Cambridge Associates in a new report.

cambridge associates private investmentsSource: Cambridge Associates’ “The 15 Percent FrontierIn 2015, for example, endowments and foundations as a whole posted a median return of just 1.3%, with more than a quarter reporting negative returns. Institutions with 15% or higher allocations to private assets, however, had a median return of 3.6%—and virtually all of them earned positive returns.

And the performance gap wasn’t just in one-year returns. Allocators with 15% or more of their assets in private investments outperformed over 10-, 15-, and 20-year periods, beating the median investor by 180 basis points per year over the last two decades.

“While private investments are considered to be riskier than marketable securities, there have been very few periods when the institutions with high private allocations underperformed those with low allocations, and when they did so, it was not by a wide margin,” the report stated.

Cambridge attributed the outperformance to venture capital, private equity, and distressed securities far outperforming public asset classes, earning annualized returns of 12.5%, 11.9%, and 10.8% respectively over the last 10 years.

As of 2015, 38% of the 174 endowments and foundations tracked by Cambridge Associates had a private investments allocation of 15% or more. The median investment in private assets was 10.7%.

The institutions with lower allocations said they didn’t have the scale or resources to build a diversified program or the ability to access the very limited group of top-tier funds in the private space. Investors were also deterred by the illiquidity of private assets.

However, Cambridge Associates said the case for higher commitments to private investments remained “compelling.”

“We see no reason to believe that the factors that produced superior returns in the past ten and 20 years will not persist into the future,” the report concluded.

Related: The Argument for Private Equity & Yale Sticks to Endowment Model, Despite Critiques