Note on Pe Asset Allocation

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Case # 5-0015

Updated August 18, 2003

Note on Private Equity Asset Allocation
Over the past 20 years, managers of institutional capital have increasingly allocated more funds to private equity. During that time period, private equity has been an asset class with relatively high returns compared to public stock market indices. However, the recent economic downturn has made it clear that this asset class also has significant risks. This note describes the characteristics and challenges of private equity as an asset class. The table below shows a sample of recent publicly announced changes in allocations to private equity by major institutional investors in 2002 and 2003. Fund Size ($Bn) 275 136 108 106 46 25 24 23 21 11 10 Old Alloc. 0% 6% 5% 3% 3% 0% 11% 3% 0% 25% 0% New Alloc. 1% 7% 8% 4% 6% 1% 8% 6% 4% 18% 2% Net Change ($Bn) 2.8 1.4 3.2 1.6 1.4 0.2 -0.7 0.7 0.8 -0.8 0.2

Organization TIAA-CREF CalPERS CalSTRS FL St Bd of Admin State of Wisconsin IB Maryland St Ret Pens Sys Colorado PERA Illinois TRS PennSERF Yale Indiana PERS

Type Private Pension State Pension State Pension State Pension State Pension State Pension State Pension State Pension State Pension Endowment State Pension

Action New Increase Increase Increase Increase Increase Decrease Increase New Decrease New

This case was written by Rob Hatch T’04 and Adjunct Assistant Professor Fred Wainwright under the supervision of Professor Colin Blaydon of the Tuck School of Business at Dartmouth College. It was written as a basis for class discussion and not to illustrate effective or ineffective management practices. Copyright © 2003 Trustees of Dartmouth College. All rights reserved. To order additional copies, please call (603) 646-0522. No part of this document may be reproduced, stored in any retrieval system, or transmitted in any form or by any means without the express written consent of the Tuck School of Business at Dartmouth College.

Note on Private Equity Asset Allocation

Case # 5-0015

St Univ Ret Sys of IL State Pension Stanford Endowment

Decrease Decrease

9 8 7 6 6 6 6 5 4 4 3 3 3 1 1 1 1

7% 17% 5% 2% 1% 0% 0% 0% 5% 0% 0% 0% 1% 0% 0% 0% 0%

5% 10% 7% 10% 2% 1% 5% 3% 10% Unknown 7% Unknown 4% 3% Unknown 5% 5%

-0.2 -0.6 0.1 0.5 0.0 0.1 0.3 0.2 0.2 Unknown 0.2 Unknown 0.1 0.0 Unknown 0.0 0.0 11.7

Los Angeles City ERS County Pension Increase 1199 Nat'l Ben & Pen Fund (NY) Union Increase Louisiana State ERS State Pension Increase Illinois Gen Revenue Fund State Pension New Indiana St TRF State Pension New Missouri SERS State Pension New United Needle Trades Employees Union Increase Arkansas PERS State Pension New San Bernardino City RA County Pension New Partners Healthcare Reviewing Boston Private Pension New Allstate Private Pension Increase Federated City ERS of San Jose County Pension New Reviewing New Hartford ERS County Pension United Food & Comm Wkrs (Oregon) Union New Chicago Pk Employees A&B Fund County Pension Total New

The decisions by some investors to reduce allocations to private equity, and other events such as IRR disclosure lawsuits and private equity funds reducing their own fund size, have left several institutional investors wondering whether private equity is an asset class that belongs in their portfolios over the long-term. Those investors that have retained or increased their allocations are struggling with how to manage their private equity investments after the historic stellar returns have evaporated.

General Asset Allocation Theory Institutional investors’ asset allocation decisions are made based on the concepts of modern portfolio theory (MPT). In essence, MPT shows that diversification may improve portfolio returns while reducing risk. Hence, rather than investing in one Center for Private Equity and Entrepreneurship 2

Note on Private Equity Asset Allocation

Case # 5-0015

company that may or may not succeed, investors should strive to be on an efficient frontier...
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