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Aon Retirement and Investment Blog

Private Equity Strategy Performance Comparisons – How Important is Strategy Diversification?

Private Equity Strategy Performance Comparisons - How Important is Strategy Diversification?

Private equity is unlike other asset classes. The Fund vehicles are often closed ended and returns cannot definitively be determined until well into a fund’s life. There are numerous factors that affect performance and the ultimate results can vary widely. In this blog we highlight two of these factors which demonstrate the need for strategy diversification:

  • Private equity markets are correlated with overall global economic conditions and cycles (albeit on a lagged basis), but some strategies exhibit their own cyclicality.
  • As with most investment opportunities, we expect strategies with higher risk to have the potential for higher returns.

Generally, when a private equity portfolio is constructed, investors should seek diversification across several areas: vintage year, geography, strategy, manager, and industry. Often, strategy diversification is thought of in terms of the risk/reward payoff; venture capital has higher return potential but also higher risk, so is often included as a higher alpha generator. On top of this, however, it is important to note that different strategies follow different cycles. This raises a couple of key questions: should one try to time vintage year commitments and focus on different strategies at different times, and how much focus should be placed on diversification across strategies in private equity portfolios?

The Burgiss database contains an array of performance metrics which can be broken down using a multitude of factors. For this analysis, we have taken the pooled Internal Rates of Return (IRR) for different private equity strategies and ranked them within each vintage year between 1997 and 2013. We have examined the following private equity strategies: distressed (“Dist.”), mezzanine (“Mez.”), natural resources (“NR”), secondaries (“Sec.”), venture capital (“VC”), expansion capital (“EC”), small buyout (“Sm. BO”), mid buyout (“Md. BO”), large buyout (“Lg. BO”), and mega buyout (“Me. BO”). We have defined the sub-strategies of the buyout space according to fund size (small < $500MM; medium $500MM - $1B; large $1B - $5B; mega > $5B). The heat map below shows the results of our analysis.


There are certain private equity strategies that are generally accepted as having greater cyclicality, and the heat map provides evidence.

Historically natural resources have been a segment of the private equity markets that has exhibited more pronounced performance cycles relative to other private equity strategies. As can be seen on the heat map, capital committed to natural resources between 1997 and 2002 has outperformed but has markedly underperformed since 2009. This is not explained entirely via one factor, but a significant proportion of the performance within this strategy is correlated with movements in oil prices (as they are a broad indicator of natural resources generally). Even within a highly cyclical industry, it can be difficult to judge when is best to balance towards or away from a certain industry. 

We would also expect to see distressed investments exhibit cyclicality, as they should outperform other strategies when the overall market/economy underperforms. Capital committed to funds focused on distressed investments before or during times of market turmoil can be seen to outperform, for example when the tech bubble burst in the early 2000s and around the financial crisis in 2007. The exact vintage year of outperformance may not exactly match the dates of a market downturn as the investment period of funds can reach out for up to five years after the fund was raised.

Risk-Return Payoff

According to Modern Portfolio Theory, we would expect the most risky strategies to strongly outperform in some vintage years and strongly underperform in others. Likewise, we would expect to see the strategies with average risk fall within the middle of the performance range more often than not. The heat map shows evidence for the risk/return trade off as we would expect.

Looking across vintage years for the venture capital strategy we can see that it is most often either the top or bottom performer in any single year and that there are only a couple of instances where it is an average performing strategy. This is what we would expect, given that the nature of venture capital investing is riskier than other private equity investments.

As we see evidence for risky strategies either dramatically out or underperforming the average, we would expect the safest strategies to consistently perform below the average. These strategies should be producing consistent but lower returns across vintage years. Again, we see evidence for what we expect in the heat map. Mezzanine is a debt focused investment strategy and compared to the other strategies within private equity which are largely equity focused, produces consistent but lower returns through time.


For any strategy, the vertical view of results shows a variety of colored and shaded boxes. This illustrates that each strategy over time experiences underperformance, average performance, and outperformance across different vintage years. As we have already examined, certain strategies are likely to out/under perform in some vintage due to the risk/return tradeoff or due to market cyclicality. If we exclude the especially cyclical and very risky strategies, we can see that it is even more difficult to identify any consistent out/under performers.

There are numerous factors that contribute to the performance of any single strategy within a vintage year and predicting the magnitude of the effect of these factors can be extremely difficult. Rather than try to analyze each factor in turn, we can look at the results of the analysis (the heat map) and draw conclusions about portfolio construction that are independent of the causes of the patterns we observe.

There is a wide dispersion of return rankings across strategies. Timing the outperformance of certain strategies is hard; a lot of any timing decision will come down to luck. The one caveat to this is that market timing ought to be slightly easier in times of market dislocation or extreme conditions. In addition to dispersion across strategies, there is also a wide dispersion in performance of individual managers within each strategy.

Sometimes investors must face tradeoffs when constructing portfolios, as there can be a conflict between diversifying to manage risk and concentrating to reflect views. At Aon, our top priority is to gain access to the best managers and funds; the difference between top and bottom performing managers is generally larger than the difference in performance between strategies. Our second priority is to diversify across strategies in a prudent way such that risk is reduced, but that the portfolio does not simply generate average market returns. The third priority is to tactically shift the weightings to each strategy at different times, depending on the prevailing economic conditions. 

Tom Wyss is a Senior Consultant on Aon’s private equity team in Chicago.

The information contained above should be regarded as general information only. That is, your personal objectives, needs or financial situation were not taken into account when preparing this information. Accordingly, you should consider the appropriateness of acting on this information, particularly in the context of your own objectives, financial situation and needs. Nothing in this document should be treated as an authoritative statement of the law on any particular issue or specific case. Use of, or reliance upon any information in this post is at your sole discretion. It should not be construed as legal, tax or investment advice. Please consult with your independent professional for any such advice. The information contained within this blog is given as of the date indicated and does not intend to give information as of any other date. The delivery at any time shall not, under any circumstances, create any implication that there has been a change in the information since the date of publication, or any obligation to update or provide amendments after the original publication date. The blog content is intended for professional investors only.

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