We are often asked:

“How should I think about constructing a portfolio of private equity funds?”

Here’s a quick and dirty framework for how you might consider building out your private equity portfolio.

Let’s say you have a $5mm net worth and you’re looking to put money to work into PE.

Asset Allocation

The first thing to determine is your portfolio allocation to private equity. Family offices are ~20% allocated to private equity.

So here, you’re looking to invest $1mm into PE funds of your $5mm portfolio.

Vintage / Time Period Diversification

The next decision to make is your time horizon for deploying your capital, or how many “vintages” you want to invest across. The goal here is to diversify over time to avoid over-indexing into a specific time period given market cycles.

In this example, we deploy across (5) vintages — meaning you invest $200K per year over five (5) years.

Manager Diversification

The last factor to consider is how many funds you want to invest in per vintage. This is where it becomes more of an art than a science.

You don’t want to invest in a fund simply because you have an annual “quota” of funds to pick — you want to invest because the investment itself is inherently attractive.

If you’re targeting 2 funds per year… some years you might pick 3 funds, some you might pick 1.

Manager selection targeting world class GPs with differentiated, competitive advantages should always be the first and foremost priority. Quality trumps all else…

However, within the scope of funds that do meet your investment criteria - it is important to diversify across GPs, investment strategies and sectors.

Another important lever here is how many funds you’re able to thoroughly diligence and the quality of your deal flow. Investing in 10 funds a year is very different from picking 1 or 2 funds a year.

For our purposes, we’re assuming we invest in 2 funds per year.

So now you are committing $100K to two (2) managers per year, or $200K per year, over five (5) years — for a total of $1mm invested into private equity.

Cash Flow Forecasting & Capital Call Timing

Now, why do we care about any of this? Isn’t this just basic arithmetic?

Where things get interesting from is the fact that an investment into a private equity fund doesn’t mean you fork over all your money on day 1.

All you are doing is “committing” the capital — or promising that when the PE fund “calls” the capital from you over the 3-5 year investment period that you’ll fund the capital.

This is where portfolio construction and cash management planning for future capital calls comes in.

As a reminder, we’re committing $200K per year across 2 funds ($100K per fund) over 5 years:

Let’s keep things very simple and say that a fund calls 20% of the capital per year over 5 years.

If we’re committing $100K per fund, this would mean we have $20K called every year for 5 years for a single fund investment.

What happens when we stack the capital calls from the underlying funds over a 10 year period?

Let’s double click this to see the breakdown of capital called for each underlying fund.

One last view from the portfolio level — how does our annual committed capital vs. capital called compare?

Great… so the math makes sense… but why do I care?

1. Even though you’re committing $200K per year, based on the pacing assumptions we laid out, you don’t actually ever have a peak cash outflow of $200K until Year 5

2. We also aren’t even accounting for distributions — that’s an entirely separate analysis we can come back to…

   • But in an ideal world, a PE portfolio can start funding future capital calls with distributions from existing PE investments once capital starts returning in the outer years (think year 5+ for a given fund)

3. All this is to say — when you “commit” $XYZ to a fund… you don’t actually need to plan to fund $XYZ right away on day 1

   • There can be some art to your commitments as you forecast and take into account your future income from your job or from other investments

At Gather Capital, we curate a set of world class private equity opportunities enabling our clients to invest alongside elite family office limited partners.

If you’re interested in learning more about what we do, feel free to:

• swing by our website & create an account (if you haven’t already)

• grab some time on our calendar here

• shoot us an email

We’re looking forward to Talking Shop with you soon.

Sincerely,