Private market asset allocation strategies for limited partners

In the intricate world of capital markets, limited partners (LPs) seek to meet risk and return objectives while navigating investment opportunities across asset classes and funds. From determining strategy to sourcing general partners (GPs), LPs rely on continuous research, accurate financial data, investment committee reviews, and insight into other LP allocation strategies to inform decisions.

This blog provides an overview of strategic allocation components for LPs within the private markets and demonstrates the benefits of effective practice. We also highlight how the PitchBook Platform and our Institutional Research Group (PIRG) support LPs throughout their investment lifecycle. To craft this blog, we interviewed our expert LP analysts, Hilary Wiek, CFA, CAIA, and Zane Carmean, CFA, CAIA, who provided invaluable insights into effective asset allocation.

In a companion blog, we’ll examine how LPs manage cash flows over time and how our tools support their ongoing rebalancing and adjusting processes.

Overview of current asset allocation trends for LPs

Our recent Global Private Market Fundraising report shows that fundraising decreased by 6% in 2023 and varied significantly across asset strategies. This decline was attributed to LPs’ heightened risk aversion amid low distributions and questionable private market valuations. Following the stock market decline in 2022, LPs found themselves overallocated, resulting in a slowdown of capital commitments. GPs haven’t been returning money to LPs at rates originally modeled, so they’re finding themselves with more illiquid assets than they expected.

Why are private market allocations beneficial to LP portfolios?

The efficient frontier, a cornerstone of Modern Portfolio Theory, offers LPs a set of optimal model portfolios that isolate the highest expected return for a certain risk tolerance. Incorporating private market investments can theoretically move the frontier upwards, leading to higher returns for the same level of risk or maintaining the same return while reducing risk.

In practice, investing in assets that have different behaviors can offer protection during market downturns, while the illiquidity premium could lead to potential gains during market upswings. Additionally, adding long-term investments to your portfolio can help mitigate emotionally driven decisions, which may result in buying high and selling low.

How does an efficient frontier correlate to risk and return?

Risk-return tradeoff directly influences where an investor allocates and is based on the principle that a higher risk begets a higher long-term reward. An institutional investor seeking to embrace the higher end of the risk spectrum will endure greater volatility and potential loss in order to seek higher upside return. These portfolios often target a larger allocation towards small-cap stocks or venture capital, whereas the conservative investor who values preserving capital and more predictable returns may have greater allocations to government and investment grade corporate bonds.

What are the macro risks and opportunities in the private markets?

The sustained increase in interest rates over the past few years compared to the period after the Great Financial Crisis (GFC) is a crucial factor for investors to consider when planning long-term investment strategies. The current return expectations for cash and core fixed income have shifted the efficient frontier upwards, meaning investors can more easily achieve their fixed return targets with less risk, as indicated in our recent Allocator Solutions: Private Market Midyear Update report.

Carmean noted that this relative attractiveness gives investors more flexibility in allocating their risk budgets, including within private markets, and determining how much total risk they are willing to take.

What is another prominent model LPs use to construct optimal portfolios?

The endowment model, pioneered by David Swenson during his time as the Yale University Endowment’s Chief Investment Officer, involves creating a diversified portfolio where the underlying assets have a low correlation to each other, reduce risk, and maximize returns. While this is not unusual, Swenson’s major departure from the norm at the time was a heavy emphasis on the asset classes beyond public stocks and bonds found in the 60/40 portfolio. The Yale model gives preference to private investments due to their illiquidity potential for higher returns by accepting illiquidity risk, explained Wiek.

Liquidity, or the ease of turning assets into cash, isn’t something an endowment with a view to perpetuity needs, allowing for a large portion of the total portfolio to be illiquid. While publicly traded stocks and bonds are also included in the model, 60% of the endowment in the 60/40 model is typically allocated to private market assets such as hedge funds and private equity.

Otherwise, Wiek emphasized that, “Most investment portfolios are the outcome of what feels right within a risk-return perspective. LPs will analyze the allocations of similar investors to understand how their portfolios compare.”

Sourcing funds and fund managers

Once an LP has narrowed down an allocation strategy, they can utilize our advanced platform search to identify open funds or funds in their chosen asset class through various filters. From there, they can view the characteristics of a shorter list and narrow down managers they’d like to perform diligence on. One quantitative aid found on the PitchBook Platform to help LPs source potential funds is our Manager Scoring tool.

Let’s look at how an LP who wants to invest in PE buyouts in the healthcare space would approach a platform fund search with the aim of finding potential GPs.

1. Select the Investors & Fund Search to narrow down the kind of GP and fund the LP wants to commit to. Go to the Investor Types section and select PE/Buyout and Primary Type Only to find a GP specializing in the space. For investor locations, we can select North America and HQ Only.

2. Fund Criteria allows you to look at funds that are open and still fundraising or at funds that are closed to see performance history. For this search, we’d like to assess the track record by selecting closed funds.

3. The fund date will be the last 15 years from 2010 onward, and the fund size will be set from 25M to 100M. Select North America for Location, then go to Industry and select Healthcare. Finally, select PE/buyout under Fund Type.

4. This search yields a shortlist of GPs and select fund information with returns data. Select Funds, Edit Table →Edit Columns, and select Fund Quartile to see how the funds compare to the benchmark. Move up the investor column.

5. This table allows you to drill deeper with specific benchmark metrics. You can see how the benchmark is performing and how each fund family stacks up compared to the benchmark.

6. Save this list and return to the Investors & Funds Search to select Open and Upcoming Funds under Fund Status to isolate managers raising money. In the Edit Column, you can change the fund status to open to identify GPs accepting investments.

7. Within the search result, go to the Funds tab → Edit Table → Edit Columns will allow you to select fund size, terms, and fees relevant to your criteria.

8. Using that same list and filters in the Investors & Funds Search, we can cast a wider net by leaving Fund Status preferences blank. Once you run that search, you can select Funds and edit the pivot table to filter for funds within the Top Quartile.

9. To continue your analysis, download this list into an Excel file and copy it into the Manager Scoring investors field.

How does our Manager Scoring tool help LPs source GPs?

PitchBook’s Manager Scoring tool utilizes a quantitative framework, allowing allocators to compare vintage years to compare fund managers in a vintage-agnostic way and identify prevalent strategies over time. Our investment style summary is incorporated into this tool and provides further insight into whether a specific firm is a generalist or specialist across several dimensions based on investment history.

Accurate insights into financial benchmarks

When determining where to allocate or put context around a fund manager’s track record, PitchBook clients can create benchmarks based on their strategy using the most up-to-date, comprehensive, and accurate fund performance data. Evaluate the fund performance of a peer group to determine the most suitable investment strategy.

Our Custom Benchmarks tool allows you to compare the performance of like funds within a set peer group based on various filters. After running the Investors & Funds Screener, you can access the Custom Benchmarks tool by clicking on the Funds tab of the results page and selecting Open Custom Benchmark from the dropdown menu.

Our benchmarking tool allows investors to:

• Create custom benchmarks for comparing a chosen fund or strategy precisely against true peers.
• Gather insights into historical returns of specific peer groups and strategies tailored to those groups, fund strategies, or geographies.
• Identify the most appropriate funds for their benchmark using criteria, including vintage year, fund size, fund type, and fund location.

Discover our industry-leading research and expert analysts

PIRG provides industry-leading analysis of market trends to help LPs stay ahead of important developments across asset classes, funds, and emerging industries. Clients can also access Morningstar’s thematic public equity research on valuations, ratings, and analysis on more public companies.

PIRG insights consultations enable LPs to contextualize current and historical market trends in order to inform allocation and diversification decisions. Beyond these resources, our platform provides in-depth asset class, industry-specific research, and fund analysis, allowing LPs to stay current on market details and developments.

Our leading LP analysts are partners in your allocation decisions, helping you navigate all stages of the investment lifecycle via quarterly and annual reports, bespoke research, and 1:1 consultation.

Meet our LP-focused PIRG analysts

Hilary Wiek, CFA, CAIA Senior Strategist

Hilary Wiek publishes primary and quarterly reporting research on the private funds landscape. Wiek also contributes to PitchBook’s coverage of the ESG/impact investing space. She has over 20 years of experience in asset owner, manager, and advisory roles. Prior to joining PitchBook, Wiek was the director of investments at the Saint Paul & Minnesota Foundations, where she handled portfolio management, impact/ESG, investment diligence and monitoring, and investment operations. Before that, she worked in senior positions at Segal Rogerscasey, the South Carolina Retirement Systems Investment Commission, Buckingham Financial Group, Dayton Power & Light, and KeyCorp.  

Zane Carmean, CFA, CAIA Lead Research Analyst, Quantitative and Fund Research

Zane Carmean is a quantitative research analyst at PitchBook, where he conducts data analysis, creates financial models, and authors research reports and thematic analyst notes covering private markets. Carmean helped launch PitchBook’s Quantitative Perspectives series, a new report style that provides a fully quantitatively-driven narrative of the current and future states of private markets. In addition, he helped build PitchBook’s proprietary valuation models to analyze the GP stakes market as well as cash flow forecasting tools to assist allocators in estimating future cash flow and commitment pacing needs. Carmean also helps build new capabilities for clients to leverage PitchBook data sets. Prior to PitchBook, he was a senior associate at Green Street Advisors where he conducted the research and analytics behind many of the firm’s strategic research reports in the commercial real estate industry.  

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