Private equity has become an increasingly important part of institutional portfolios. Investors are attracted to its long-term return potential, the ability to influence portfolio companies and, perhaps less explicitly, the relatively smooth performance that comes from periodic rather than daily valuations. But what exactly are investors being compensated for? And how much of private equity's return profile can be recreated in public markets? My guest today is Randy Cohen, Professor of Finance and Entrepreneurship at Harvard Business School and Co-Founder of PEO Partners. Randy has spent much of his academic career studying asset pricing, investment management, and the challenge of identifying genuine investment skill. Randy and I go back to our days at the University of Chicago, where Gene Fama's work provided a foundation for how we think about markets, risk, and expected returns. In our conversation, Randy describes an approach to private equity replication that begins with the economics of a leveraged buyout. Companies attractive to buyout investors generally exhibit strong profitability, attractive valuations, healthy cash generation and relatively manageable business risk. These characteristics overlap meaningfully with established equity factors. Add industry selection and a measured amount of leverage, and Randy argues that a liquid portfolio can capture important elements of traditional private equity exposure. Of course, the differences matter. Private equity managers can make operational improvements and exercise control. Public portfolios offer liquidity but expose investors to daily market volatility. And the smoothing of private valuations, what Cliff Asness has called volatility laundering, complicates the comparison. We discuss these trade-offs, the substantial role of fees, and the potential for liquid private equity to serve as a complement rather than a replacement for traditional allocations. I hope you enjoy this episode of the Alpha Exchange, my conversation with Randy Cohen.
Private equity has become an increasingly important part of institutional portfolios. Investors are attracted to its long-term return potential, the ability to influence portfolio companies and, perhaps less explicitly, the relatively smooth performance that comes from periodic rather than daily valuations. But what exactly are investors being compensated for? And how much of private equity's return profile can be recreated in public markets?
My guest today is Randy Cohen, Professor of Finance and Entrepreneurship at Harvard Business School and Co-Founder of PEO Partners. Randy has spent much of his academic career studying asset pricing, investment management, and the challenge of identifying genuine investment skill. Randy and I go back to our days at the University of Chicago, where Gene Fama's work provided a foundation for how we think about markets, risk, and expected returns.
In our conversation, Randy describes an approach to private equity replication that begins with the economics of a leveraged buyout. Companies attractive to buyout investors generally exhibit strong profitability, attractive valuations, healthy cash generation and relatively manageable business risk. These characteristics overlap meaningfully with established equity factors.
Add industry selection and a measured amount of leverage, and Randy argues that a liquid portfolio can capture important elements of traditional private equity exposure. Of course, the differences matter. Private equity managers can make operational improvements and exercise control. Public portfolios offer liquidity but expose investors to daily market volatility. And the smoothing of private valuations, what Cliff Asness has called volatility laundering, complicates the comparison.
We discuss these trade-offs, the substantial role of fees, and the potential for liquid private equity to serve as a complement rather than a replacement for traditional allocations.
I hope you enjoy this episode of the Alpha Exchange, my conversation with Randy Cohen.