A Fair Comparison Framework: Risk and Reward in Private & Public Investments

PGIM Institutional Advisory & Solutions

November 2019

Institutional investors have increasingly allocated to illiquid private assets for the potential diversification and private asset premium benefits. Institutional private asset opportunities are today broadly available, and CIOs must decide how to allocate their marginal portfolio dollar not only between equity and credit, but also between public and private vehicles.

How can a CIO compare an investment with a higher expected return, but higher return uncertainty, with another investment with a lower expected return but lower risk? A natural way is to rank them based on their return-per-unit-of-risk. But such a comparison is difficult if the expected returns and risk for some investments are not measured reliably. This is an issue for private investments due to their illiquid nature, the absence of market prices and the confidentiality of the related performance data.

To highlight the issue, Figure 1 shows the growth of a dollar in various U.S. investments between 2005 and 2018, reflecting linked periodic returns (e.g., quarterly IRRs for private assets and total returns for public assets). It appears buyout private equity funds were the best investment by a wide margin, followed by mezzanine credit funds.

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