Private Equity Risk Budgeting

Richard Horwitz

We all believe that immobile objects cannot move. For example, a mountain seems to be entirely immovable. However, over time cracks and fissures form. As these grow bigger, most people who observe the mountain, view it as a secure behemoth. Then one day the cracks reach a critical point. Potential energy converts to kinetic energy and the seemingly immobile mountain has a landslide. This is a metaphor for the risk of private equity.

From the early years of the 21st century the average endowment has increased its exposure to alternative assets (including private equity) from 8% to 44% and the largest ones have increased it from 20% to 60%.¹¹NACUBO–Commonfund Study of Endowments. An annual study carried out by the National Association of College and University Business Offices and the Commonfund. During the same period in the US the average state pension fund has increased its exposure to alternative investments from 9% to 23%.²²Wilshire Report on State Retirement Systems: Funding Levels and Asset Allocation. An annual study by Wilshire Consulting Private equity has become a material proportion of the overall risk of institutional investors.

Against this backdrop, virtually no