Private Equity (Correlation with public markets)

CFA Level III
#1

On page 38/Reading 26 (2nd para), it clearly says that Private Equity (PE) has low correlation with public markets…

Notwithstanding the solution,

On PM mock, #45, solution says that PE has moderately high average correlation!!

#2

This is one way to keep that pass rate low. Am I right? :wink:

#3

Write CFA Institute (info@cfainstitute.org) and let them know.

Please let us know their reply.

Thanks.

#4

Private equity should technically have low-average correlation with public equities, thus providing diversification benefit

#5

PE is a moderate risk diversifier. Pls post the para from Curriculum for further discussion.

#6

PE has high correlation with public equity. The CFAI text was comparing data that was smoothed because of infrequent valuations, which ended in low correlation.

#7

Thanks all- just trying to figure out what will get credit on exam. I see the point of smoothed data that ejs190 mentioned, but the language below (from section 4.2.2/page 38 of Reading 26):

_ Private equity returns have exhibited a low correlation with the returns to publicly traded securities, making private equity an attractive addition to a portfolio. However, because of a lack of observable market prices for private equity, short-term return and correlation data may be subject to the smoothing effects of stale prices_.

this “may be” is what creates confusion

#8

Mentioning "_ high average correlation " (on mock solution) and then mentioning " private equity an attractive addition to a portfolio" _ (in curriculum) is quite ambiguous.

try even attempting something like above at work, and you will see the consequence:) anyway, just want to pass this!! and not debate what happens in real world of finance.!!

#9

Got official confirmation- please go with what’s in the curriculum. the mock question has some ambiguities.

Conclusion: PE has low correlation with public markets

#10

Bad conclusion in my opinion. Private equity is basically leveraged small/mid cap value listed equity. The low correlation is purely due to stale prices (infrequent valuations). Look up any private equity index, it’ll look like a step function.

I recommend checking out the paper Replicating Private Equity with Value Investing, Homemade Leverage, and Hold-to-Maturity Accounting by Erik Stafford. For those interested in the real world of finance vs. CFAI’s version :wink:

#11

pretty sure nobody here has any interest in real world fiance vs CFAI’s version right now

#12

Schweser practice exams Vol. #2 PM exam # 1 Q38 answer says " … the return tend to be correlated with stock return. this lower the amount of diversification private equity can offer a standard stock and bond portfolio"

#13

Yeah and in the notes they say PE is more of a return enhancer than a diversifier in a typical stock/bond portfolio.

#14

:+1:

#15

This is frustrating, but I’m going with the CFAI on this. No reason not to, even if it’s wrong.

#16

Don’t fight the institute, get your charger then argue with anyone you want in work place… have to agree with rpearce12 go with CFAI on not just this one but all disagreements…

#17

Was just reviewing the topic tests again and found the following in the Duke Partners Asset Management Case Scenario under Alternative Investments:

“Private equity investments have low liquidity and provide relatively low diversification benefits with publicly traded equities.”

So CFAI is contradicting itself by on the one hand saying low correlation and in the topic tests saying low diversification benefits (i.e. high correlation). I’m going with the latter.