Driven by strong returns, private equity has seen unprecedented growth during recent decades. For example, a study by McKinsey & Co. showed that net asset values in private equity have outgrown public equities market capitalization nearly threefold since 2000. And the trend remains unbroken: in our Annual Investor Survey of private equity investors, 60% of them increased their allocations to the asset class in the past 12 months.

However, investing in private equity has its pitfalls. Generating large returns does not come without risks, because there is large dispersion in returns across buyout and venture capital (VC) managers. In a large sample obtained from Preqin, close to 10% of all buyout funds had negative returns, and more than 35% doubled their money. For VC, the loss ratio is much higher, as more than a quarter of VC funds return less than the invested capital and roughly 30% of funds have a multiple over 2x.

Deep knowledge of the asset class and strong selection skills are therefore of utmost importance for an investor that commits directly to buyout and VC funds. With substantial long-term experience, investors can make use of the right-skewed dispersion of private equity returns and benefit from it by generating returns higher than those of public markets.

Fortunately, secondary funds, which provide liquidity by buying the interests of existing funds, offer investors without that long-term experience access to the asset class, with similarly attractive return characteristics but with much lower-risk profiles. To illustrate the point, the following chart plots all of the internal rates of return (IRRs) for funds with vintage year 2015 or older from Preqin, clustered by their strategy. Blue dots below the orange line represent funds with negative IRRs. The rectangles show the lower and upper quartiles as well as the median (line in the middle).