Asset Allocation 101: Getting your equity allocation “right”


Third Wire Editorial


Asset Allocation 101: Getting your equity allocation “right”

The question of how to categorize private equity and whether it belongs to the realm of “alternative investments” might strike some as ‘stupid’ but it isn’t just a matter of semantics. It’s actually pretty important. This isn’t just about labels; it’s about accurately assessing and managing risk in your investment portfolio and avoiding an inadvertent over-allocation to equities, skewing the intended risk balance of your portfolio. 

Alternative investments have historically been defined as anything outside of stocks, bonds, and cash/cash equivalents. It’s easy to see why many might default to classifying private equity as an alternative. After all, private equity doesn’t neatly fit into these categories. Others seem to have decided to relabel ‘Alternative Investments’ as ‘Private Markets’ and then place private equity and private credit at the heart of it—which risks marginalizing investments like hedge funds and CTAs, i.e., alternative investments that have historically played a vital role in mitigating risk and enhancing returns within diversified portfolios. 

The crux of the issue with allocating to private equity from the alternatives bucket is it can lead to a de facto over-allocation to equities. Here’s why:

  • Equity-like Characteristics: At their core, private equity investments share more characteristics with public equities than with traditional “alternative investments” or fixed income. They are fundamentally about equity ownership in companies, albeit through a different investment structure. This means they carry a similar risk-return profile to equities, including the potential for high returns accompanied by high risk.
  • Risk Profile Misalignment: By considering private equity as an alternative and allocating to it outside of the equity portion, investors may inadvertently skew their portfolio’s risk profile. They end up with a higher overall exposure to equity-like risk than intended. This misalignment can be particularly problematic for investors with specific risk tolerance levels and investment horizons.
  1. In a traditional 60/40 portfolio: Allocating to private equity from the equities side (60%) acknowledges private equity’s inherent risk and return profile, which more closely mirrors that of equities than bonds. This approach ensures that the risk level of your portfolio remains aligned with your investment goals and risk tolerance.
  2. In a more modern 50/30/20 portfolio approach: Allocating to private equity from the 50% equities portion rather than the 20% allocated to alternatives reinforces the idea that private equity investments are a subset of your equity exposure. This method clarifies your actual risk exposure by not artificially inflating the perceived safety of your portfolio through misallocation.

Our stance on counting private equity as part of the overall equities segment is rooted in several key considerations:

  • Risk Profile: Private equity, like public equities, carries a higher risk (and potentially higher return) profile compared to bonds and cash equivalents. Both private equity and public equities aim for capital appreciation over the long term, albeit through different mechanisms and structures.
  • Market Dynamics: While private equity investments are not subject to daily market fluctuations like publicly traded stocks, they are still influenced by the same underlying market and economic forces. Their valuation may be less visible, but they are not immune to market dynamics.
  • Investment Horizon and Illiquidity: private equity investments typically require a longer commitment and are less liquid than public stocks, reflecting a risk factor that needs to be accounted for within the equity portion of a portfolio. This long-term, illiquid investment approach is a characteristic of value equity investing, where patience is often rewarded with higher potential returns.
  • Diversification Strategy: By allocating private equity from the equity portion of your portfolio, you’re diversifying your equity exposure across different market segments—private versus public—and accounting for it appropriately. 

Categorizing private equity as an equity investment rather than an alternative investment is not merely a semantic exercise; it’s a reflection of a deeper understanding of its role in a diversified portfolio. This approach encourages investors to think more critically about their risk exposure and investment strategy, ensuring that private equity investments are aligned with their overall portfolio objectives.

Let’s talk about how we can help you and your clients navigate the alternative investment industry and improve your chances of success. 


This article is for informational and educational purposes only and should not be construed as providing tax or legal advice. It does not take into account the specific investment objectives, financial situation, or particular needs of any reader. Readers should consult with their own tax, legal, and financial advisors to determine the appropriateness of any investment strategy or approach mentioned herein. Investing involves risk, including the possible loss of principal.