Private Equity – The 3 I’s Before You Buy

Some of the hottest words in markets: Private Equity. 

When investors talk about private equity, a few things come to mind: exclusivity, high returns, and diversification. These characteristics make the asset class perfect for conversations with friends and colleagues, but does it live up to all the lofty expectations? Here, we will dive into what truly defines private equity and if it is right for your portfolio.

One of the greatest allures of private equity is the possibility of investing minimal capital and landing an investment with exponential returns. Companies like SpaceX have made many of their employees and early investors multi-millionaires through private equity. So, why not allocate a portion of every portfolio to private equity with hopes of this same outcome? There are 3 main things to consider before buying private equity in retail investor portfolios: Inaccessibility, Illiquidity, and Illusions.

Inaccessibility is one of the biggest hurdles with private equity. When innovative startups such as Google or SpaceX seek early-stage investor capital, they primarily market to institutional investors such as hedge funds and large endowments. While these large firms invest early, retail investors are left on the sidelines. For example, SpaceX shares were not available to retail investors until the company’s IPO in June of 2026. Mutual Funds and ETFs offered minority exposure to SpaceX as early as 2024, but these funds have not performed the same as having direct SpaceX shares from an early stage. On the contrary, some hedge funds and endowments have held SpaceX shares for over 10 years prior to the IPO. Private equity is best if you have direct access from an early stage, which is not possible for most retail investors. Then, during the times when it is available, investors are subject to capital calls. This is when partners reach out requiring you to invest more money to avoid ownership dilution. When most retail investors buy into private equity, they are buying late-stage companies within funds that have many other holdings. Then, not only are these funds holding many different private investments that are less attractive, but annual management fees on these funds can reach as high as 7%. At the end of the day, these funds are expensive and do not provide the same access given to hedge funds and endowments.

The second “I” to be considered before buying private equity in a retail portfolio is illiquidity. Private funds, otherwise known as interval funds, are highly illiquid. Some offer redemption windows (typically quarterly), but investors are not guaranteed to redeem any shares in any given quarter. These windows are often oversubscribed, and investors will be turned down from accessing their capital. When you need your money most, it is simply inaccessible.

Finally, in addition to inaccessibility and illiquidity, private equity suffers from two different illusions: Backfill Bias and Volatility Smoothing. When hedge funds publish their historical risk and return metrics, you must be wary of both of these biases. Backfill Bias occurs naturally because underperforming funds go out of business which leaves only the winners to report their returns. According to The Hedge Fund Journal, about 5-10% of hedge funds close or cease reporting every year. This effect causes returns across the asset class to look artificially high. On the volatility side, many private investment funds are only priced quarterly. By only reporting the investment value 4 times per year, you ignore all the price fluctuations that occur between valuation dates making the volatility appear artificially low. This effect is known as Volatility Smoothing. Backfill Bias combined with Volatility Smoothing can make private equity appear significantly more attractive than it is.

When it comes to building a diversified portfolio, private equity has a time and place. Unfortunately, the time and place is not typically in retail investor portfolios. Multi-billion-dollar hedge funds and endowments can benefit greatly from having direct private equity exposure, but the average investor, even one of high net worth, is not necessarily well suited to place their money into illiquid underperforming funds. At Covington, we believe that owning a diversified portfolio of high-quality public equities can produce strong investment returns over long periods of time.