Private equity is increasingly viewed not as a replacement for public markets, but as a supplementary component of a well-rounded investment portfolio. While public equities remain foundational for liquidity and broad market access, private equity offers exposure to parts of the economy underrepresented in public markets, particularly the U.S. middle market, and serves as a long-term diversifier that can help improve risk-adjusted returns and broaden economic exposure.

It’s important to recognize that the public equity markets do not fully reflect the breadth of the U.S. economy. The top 10 companies by market capitalization now comprise approximately 30% of the total U.S. market cap, yet they contribute only 20% of earnings before interest and taxes (EBIT), 15% of total sales, and just 2% of overall employment. In contrast, the U.S. middle market represents roughly one-third of private sector GDP and would rank as the third-largest economy in the world if it stood alone. These companies span diverse industries and are often deeply embedded in domestic economic activity. By allocating to private equity, investors gain access to this broader economic engine, which is largely inaccessible through traditional public market indices.[1]

Private equity also brings structural advantages that has the potential to contribute to long-term performance. A defining feature of the asset class is its alignment of interests between owners, managers, and employees. Private equity firms typically invest alongside management teams and work directly with portfolio companies to implement strategic, operational, and financial improvements. Without the quarterly earnings pressure that often influences public company behavior and high-frequency trading, private equity-backed companies are better positioned to invest in long-term initiatives that can drive sustainable growth.

From a performance standpoint, private equity has historically delivered compelling risk-adjusted returns. Between 2015 and 2023, the Preqin Private Equity Buyout Benchmark[1] posted a Sharpe ratio (a measure that exhibits how much excess return you are receiving for the amount of risk you are taking) of 1.3 which outpaced public indices such as the S&P 500[2] (0.62), the MSCI ACWI ex-US[3] (0.22), and the Russell 2000[4] (0.37). While private equity valuations are less frequently marked to market, and this can understate volatility, the consistently higher Sharpe ratio still signals a favorable balance between return and risk over longer time horizons. This makes private equity a useful ballast during periods of public market volatility and an important diversifier within portfolios.[1][2][3]

It is also worth noting that private equity is not immune to challenges. Its illiquid nature, higher fee structures, and variability in manager performance require thoughtful allocation and careful manager selection. Additionally, the timing of commitments across different “vintage years” is important to reduce exposure to unfavorable market environments and spread investment risk over time.

Ultimately, private equity is not a substitute for public equity, but a complement. It enhances diversification, broadens economic exposure to the underlying domestic economy, and provides a different set of tools for long-term value creation. For investors with a long-time horizon, sufficient liquidity, and a desire to diversify beyond the public markets, private equity can play a constructive and stabilizing role within a well-balanced portfolio.

[1] FS Investments: Fueling Growth: Mid-market PE and the U.S. Economic Boom

[2] The Preqin Private Equity Buyout Index covers over 14,000 closed-end funds captured in the broader Private Capital index including funds/strategies listed as Buyout, as defined by Preqin.

[3] The S&P 500, or Standard & Poor’s 500, is a stock market index that measures the performance of 500 of the largest publicly traded companies in the U.S., serving as a key indicator of the overall health of the U.S. stock market.

[4] The MSCI ACWI ex USA Index captures large and mid cap representation across Developed Markets (DM) countries (excluding the US) and Emerging Markets (EM) countries.

The Russell 2000 Index is a small-cap U.S. stock market index that makes up the smallest 2,000 stocks in the Russell Index.

[5] The Russell 2000 Index is a small-cap U.S. stock market index that makes up the smallest 2,000 stocks in the Russell Index.

[6] Preqin Alternative Assets Data

[7] iCapital Alternatives Decoded: Navigating the World of Alternative Investments Q4 2024

[8] Bloomberg LP