Building an Investment Portfolio

What’s in this section:

When building and maintaining your investment portfolio, diversity is important. One way to diversify is by investing in different asset classes. But one size does not fit all. The amount you allocate to each asset class will depend on your personal circumstance and investment goals.

Asset Classes in an Investor’s Portfolio

Let’s review the main asset classes:

Public Equity/Stocks

A share in the ownership of a public company. Typically provides moderate returns with varying product risk profiles.

Bonds (or Fixed Income)

A debt instrument; an investor loans money to a corporation or government that borrows the funds for a fixed time period at a fixed interest rate. As a lower risk investment type, the returns tend to be lower. 

Real Assets

Physical or tangible assets that have value, due to their substance and properties. Real assets include precious metals, commodities, real estate, agricultural land, and oil. 

Cash/Cash Equivalents

Cash, bank accounts, and equivalents, which include Treasury bills, bank certificates of deposit, bankers' acceptances, corporate commercial paper and other money market instruments. These securities are low-risk, with corresponding low returns.

How much of your portfolio is allocated to each asset class?

The typical retail investor’s portfolio – breaking it down:

Let’s look at the average retail investor’s portfolio and you can see how yours compares:

Average U.S. Household Portfolio (2006 – 2010) 

  • Stocks:* 36.5%
  • Bonds: 19.4%
  • Cash: 17.3%
  • Real Estate: 19.4%
  • Other: 1.6%

*Includes U.S. and International stocks

Source: AdviserPerspectives.com



Now let’ compare the retail investor’s portfolio to the more sophisticated investor.

The Professional Investor’s portfolio

Let’s compare the retail investor’s returns to those of the professional investor.

The "Endowment" Portfolio

A large "endowment", which manages more than a billion dollars on behalf of universities, charities, and hospitals, had an average return of 8.2% over the past 10 years!

What are they doing differently than most investors?

Exposure to private equity of select college endowment funds (2015): 1

As you can see, many prominent college endowment funds allocate a large percentage of their portfolios to private equity.  One of the largest and most successful endowments, the Yale Endowment, which manages over $23 billion, is a huge proponent of private equity investing. And for good reason! Yale’s endowment earned a 20.2% investment return in 2014. 2  Wow!  Let’s look at how their portfolio breaks down:

  • Private Equity: 28%
  • Venture Capital: 23%
  • Hedge Funds: 17%
  • Real Estate: 25%
  • Public Equity: 4%
  • Other: 3%

The Yale Endowment is investing in private equity more than any other asset class!

The "Pension Fund" Portfolio

Large pension funds invest millions and millions of dollars on behalf of Americans for their retirement.  Let’s look at how a Pension Fund invests: 3

  • Public Equity: 51%
  • Fixed Income: 24%
  • Private Equity: 10%
  • Real Estate: 7%
  • Other: 5%
  • Cash: 3%

  A recent study found that the median public pension portfolio received 8.8% in returns from private equity, compared to 3.7% in public equity and 5.7% in total portfolio returns, annually over the past 10 years. 3  Shouldn’t you be investing for your retirement in the same way?

The "Ultra-Wealthy" and "Rich" Investor’s Portfolio

Let’s look at the Ultra-wealthy:

According to TIGER 21, a peer-to-peer network for ultra-high-net-worth investors (net worth between $10 million and $100 million) in Q1 2016, members allocated 23% of their assets to private equity - even more than the 22% they allocated to public equity!  4

They must be doing something right because they are 23X richer than the average investor.

What about the High-Net-Worth Investor?

According to data provider Prequin, between 2011 and 2013, affluent investors (high net worths) allocated 19% of their portfolio to PE. This is up from 11% during the 2008-2011 period.

Industry research shows that professional investors and the wealthy invest at least 10%, and up to 30% of their portfolio in private equity - and 46% of them plan to increase their private equity allocation by 2017: 5

How are investors expected to change capital allocations to private equity by 2017?

Source: EY 2015 global private equity survey

Average Asset Class Returns

Why are the ultra-wealthy increasing their private equity holdings? Let’s examine the average returns of the various asset classes, including private equity.

Average 10-Year Returns (ending 2015)

 

Average Returns to 2015 Avg 5yr Returns Avg 10yr Returns
Private Equity 6 14.7% 11.8%
Venture Capital 6 17.7% 11.0%
Treasury Bill (3-month) 7 1.4% 1.1%
Bonds 8 3.7% 5.3%
S&P 500 9 11.1% 6.9%
Russell 2000 10 7.3% 5.4%

 

Notice that Private Equity returns more than all of the other asset classes!

Unfortunately, not allocating to private equity means a lost investment opportunity because this asset class delivers such significantly higher returns than each of the stocks, bonds, and cash asset classes.

Why retail investors don't have access to private equity

 

So why does the average household portfolio look so different? Why doesn’t the retail investor have an allocation to private equity?
Retail investors have been shut out from private equity for 2 main reasons:

  1. PE firms require extremely high minimum investment sizes to gain entry, usually at least $1 million, but often, they are much higher. For example, most Canadian PE investments are between $15 to 50 million.
  2. Even if a retail investor had the million-dollar check required to invest, they wouldn’t know where to source PE deals. That’s partially due to heavy advertising restrictions that were imposed by the regulators
    (until now…but we will get into that later).

 

Sources:

  1. http://markovprocesses.com/blog/2015/11/mpi-dsa-unlocks-top-endowment-performance-1/
  2. http://news.yale.edu/2014/09/24/investment-return-202-brings-yale-endowment-value-239-billion
  3. http://www.investmentcouncil.org/app/uploads/long-term-commitments-the-interdependence-of-pension-security-and-private-equity5.pdf
  4. https://tiger21.com/market-conditions-spur-investment-private-equity-says-tiger-21-report
  5. www.ey.com/Publication/vwLUAssets/EY-2015-global-private-equity-survey/$File/EY-2015-global-private-equity-survey.pdf
  6. Cambridge Associates United States PE/VC Benchmark report, Sep 2015
  7. http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html
  8. https://www.ishares.com/us/products/239458/ishares-core-total-us-bond-market-etf
  9. Google Finance: S&P 500 returns
  10. http://www.ftse.com/products/indices/russell-us