Public markets are no longer the broad economic barometer they once were. With fewer listed companies and a narrowing range of economic exposures, they may not be able to provide investors with all the tools needed to construct a fully diversified portfolio. Private equity, on the other hand, has evolved into a significant source of economic opportunities that public markets may struggle to replicate. By including this asset class, investors can access exposures distinct from public markets and benefit from skilled managers generating uncorrelated, excess returns. The result could be a meaningful enhancement of the portfolio’s overall risk-return profile.
We also provide an analysis of the correlation between private equity and public markets. While the data highlights low correlation, the true value of private equity lies in its ability to access diverse opportunities and leverage active management, making it a powerful addition to a diversified investment strategy.
The public markets, despite their structural decline, still offer a vast array of investment opportunities. However, contrary to common criticisms, the argument for including private equity in a portfolio isn’t about simply utilizing debt to create a leveraged investment on the large quantity of public equities; it’s about providing access, access to something the broader market cannot invest in – private companies. As the economy evolves and public markets move accordingly, private equity increasingly appears to offer further optionality for allocators seeking distinct sources of alpha with great value creation opportunities—a shift with profound implications for modern portfolio construction.
A groundbreaking 2022 study [1] by two U.S.-based professors asked a critical question: has the stock market become less representative of the economy? The answer is unequivocal. Listed firms contributed significantly less to employment and GDP in the 2010s compared to the 1970s. In other words, the public market is losing its economic relevance, while private companies have grown into an indispensable driver of economic activity.
This trend stems from how industries evolve. Manufacturing firms, with their large capital needs, often turn to public markets, while service-oriented businesses, which are lighter on tangible assets, tend to remain private. The rise of the intangible economy amplifies this divergence, leaving public markets increasingly dominated by sectors that don’t represent the full breadth of economic activity.
This self-selection means private equity offers genuinely distinct economic exposures, elevating its role as a diversification powerhouse. Academic research supports this. A study [2] by professors from Yale, Oxford, and ESSEC examined over 3,300 private equity funds since 1983. Their findings were clear: private equity, amongst other private market asset class’ returns, are only partially explained by public market factors (Figure1). Private ownership introduces unique risks and opportunities—sources of factor risk premia unavailable in public markets.
Further analysis confirms the practical benefits. Another study simulated portfolios from 1987 to 2018, replacing portions of public equity with private investments in buyout, venture capital and real estate funds. The result? Portfolios with private equity consistently delivered higher average returns and Sharpe ratios, particularly when including buyout and real estate funds.[3]
The advantages of private equity aren’t just academic. During the 2022 market downturn, public equities saw massive losses, largely driven by tech giants like Microsoft, Meta and Amazon. Bain & Company’s global private equity report[4] highlighted a stark contrast: private portfolios, while also tech-heavy, were dominated by enterprise Software as a Service (SaaS) companies with recurring revenues and stable cash flows. This subtle implementation difference is a great example of the optionality available within private equity. You can build an implementation in an exciting strategic vertical to capture market-wide growth, but through a nuanced exposure that provides resilience, protecting against market reversals or global economic headwinds. This kind of optionality simply isn’t as readily available within the listed market opportunity set.
Private equity also shines in recession-resistant sectors like healthcare and in emerging opportunities within the climate transition. While public markets host some of the world’s largest emitters, private equity is funding a wave of innovative companies developing technologies to combat climate change—a key differentiator for sustainability-focused investors. We refer interested readers to our white paper in this space.[5]
For data-driven investors, correlation analysis provides further evidence of private equity’s diversification potential. Pitchbook data shows that buyout strategies have an average correlation of 0.72 with the S&P 500, while venture capital funds are even less correlated at 0.57 (Figure 2).
Harvard Finance Professor Victoria Ivashina corroborates these findings, citing correlations of 0.54 for venture capital and 0.76 for all private equity strategies combined from 2001 to 2020. Professor Ivashina aptly concludes, “Given these numbers, the question of whether private equity should be treated as a distinct asset class might appear to be settled.”[6]
Private equity’s role as a diversifier is grounded in its ability to offer exposures and opportunities that public markets may struggle to replicate. Whether it’s the resilience of private portfolios, their alignment with emerging economic trends, or their statistically lower correlations with public assets, private equity stands out as an essential tool for enhancing portfolio construction. Public markets still offer a vast array of investment opportunities. However, in today’s complex and evolving financial landscape, overlooking private equity is no longer an option – it’s a missed opportunity.
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