Amortizing Volatility across Private Capital Investments

This article reviews the amount of systematic risk that exists within private capital investments through the methodology of lagged betas. The author extends the lagged beta research beyond private equity and venture capital to other illiquid asset classes, including secondary private equity, private credit, and private real estate investing. He finds that considerable amounts of market risk, growth exposure, and small-cap factor risk are embedded across the illiquid asset classes. In addition, he notes that private capital managers have significant discretion as to when and how they mark to market or mark to model the value of their investment portfolios. This discretion allows private capital managers to smooth their return profile and, effectively, amortize the volatility embedded in their private investments. The author demonstrates, using lagged betas, how to un-smooth private capital returns to better estimate their latent volatility and their higher correlation with traditional asset classes.