Hey - so this is really confusing me. In schweser exams 2 AM there is a question about the diversification benefits or lack of, of a middle market buyout fund. The answers say that the Buyout fund is not correlation to equities therefore is a good diversification tool however I have in my notes (from another question, no doubt) that buyout funds are quite highly correlated to equity markets as the primary exit mechnasism is an IPO… Therefore they are good return enhancers… Any ideas?
anyone?
Private equities such as buyout or venture capital funds provides some diversification benefits to a traditional equity / fixed income portfolio. However the true benefit of investing in private equities is that they provide enhanced returns.
It depends on the type of buyout fund . In the distressed security type of alt investment, on Page 94 top paragraph they say that buyout funds invested heavily in distressed , troubled or bankrupt companies . These would not be correlated to equities . ( they are event driven , j-factor driven , and illiquidity drien , all completely irrelavant to the normal equity market.
Otherwise buyout funds could buy out a running company with established revenues , products and customers , take it private , jigger the balance sheet to change its debt structure (i.e. over-leverage it ) and sell it off in 2-4 years either through IPO , dividend recapitalization, or to another venture partner. These companies would be mainstream companies highly correlated to the equity market
Private equity offers an illiquidity risk premium not offered in public equities, Therefore, PE exposure diversifies equity exposure due to the illiquid nature of their fund structures.