Reimagining the 60/40 Portfolio with Private Equity Secondaries

October 3, 2024
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Secondary private equity can potentially enhance the return and risk profile of a traditional 60/40 portfolio.

The core investment portfolio needed to balance return and risk–long viewed by financial advisors as a prototypical 60/40 stock/bond allocation–is taking on a different look. We believe advisors are coming to the same conclusion as institutional investors: alternatives are not alternatives anymore.

Accordingly, advisors appear to be making alternatives a core component of strategic asset allocations. As a result, some investors are seeking to add private markets to portfolios to potentially achieve greater longer-term returns and mitigate risk.

A long track record of higher returns and lower risk

Secondary private equity (PE) has emerged as an alternative way to access private markets. Investors may benefit from its potential for attractive returns, modest volatility and lower correlations to other asset classes.

Over the long term, secondary private equity has delivered higher absolute and risk-adjusted returns compared to public equities (Exhibit 1).

Exhibit 1: Secondary PE has outperformed public equities with less risk

Annualized returns and risk: 20 years ended 12/31/2

As of 12/31/23. Source: MSCI, Bloomberg and Cambridge Associates. Past performance is no guarantee of future results. See disclosures for index definitions and other disclosures.

Historically strong downside protection

When broader market conditions deteriorate, secondary private equity investments have exhibited lower volatility and downside risk compared to public equity, and even primary private equity investments (Exhibit 2).

Exhibit 2: Secondary PE has delivered stronger historical downside protection

Cumulative returns during equity drawdown periods

As of 12/31/23. Source: Pomona Capital, Capital IQ (S&P), Cambridge Associates (CA Index). Data show cumulative quarterly returns during drawdown periods from 1999 to 2023. Past performance is not an indication of future performance. There is no guarantee that an investment in a Pomona-sponsored fund will ultimately be profitable. See disclosures for index definitions and other disclosures.

Secondary PE: A potential path to more attractive risk-adjusted returns

Adding secondary private equity to a 60/40 portfolio is a possible strategy to help enhance risk-adjusted returns. As the data below illustrates, reallocating a portion of the portfolio from public equities and bonds to secondary private equity enhanced the risk-return profile of the portfolio (Exhibit 3).

By strategically incorporating secondary private equity into a traditional 60/40 allocation, advisors can seek to enhance risk-adjusted returns, diversify their holdings, and create a more balanced and resilient investment strategy for their clients’ portfolios.

Exhibit 3: Adding secondary PE to a 60/40 portfolio increased returns and lowered risk

Annualized returns and standard deviation for 20 years

As of 12/31/23. Assumptions: Portfolio with Secondary PE takes 50% of the allocation from Bonds and Stocks each. Indices used: Cambridge Associates Secondary Index; Stocks: MSCI
World Index; Bonds: Bloomberg U.S. Aggregate Bond Index.⁵

The above reflects an investment in the stated allocations if invested on 01/01/04 and held through 12/30/23. The data above is for hypothetical purposes and is intended to show potential returns that may be achieved based on the above investment allocations across equity, private equity, and fixed income in a particular portfolio. It Is not intended to show actual returns for each portfolio in every case. The statements made above are the opinions of Pomona Capital and are subject to change. There can be no assurance that any investment made in a Pomona fund will have any or all of the investment characteristics described herein. Prospective investors should consult their financial, tax and legal advisors prior to making a commitment to any Pomona-sponsored fund. Investments in private equity involve a substantial degree of risk; there is no guarantee that any investment in a Pomona-sponsored fund will ultimately be profitable and an investor could lose some or all of its investment. Past performance is not indicative of future results. Please read in conjunction with footnotes and disclaimers.

A note about risk

Investing in private equity is a risk and there is no guarantee that an investment in private equity or in a Pomona-sponsored fund will be profitable. The above scenarios are for illustrative purposes only and are theoretical; there is no guarantee an investment in a Pomona-sponsored fund will exhibit any of the above characteristics or return profile.

Discussed below are the investments generally made by Investment Funds and the principal risks that the Adviser and the Fund believe are associated with those investments and with direct investments in operating companies. These risks will, in turn, have an effect on the Fund. In response to adverse market, economic or political conditions, the Fund may invest in investment grade fixed income securities, money market instruments and affiliated or unaffiliated money market funds or may hold cash or cash equivalents for liquidity or defensive purposes, pending investment in longer-term opportunities. In addition, the Fund may also make these types of investments pending the investment of assets in Investment Funds and Co-Investment Opportunities or to maintain the liquidity necessary to effect repurchases of Shares. When the Fund takes a defensive position or otherwise makes these types of investments, it may not achieve its investment objective.

The value of the Fund’s total net assets is expected to fluctuate in response to fluctuations in the value of the Investment Funds, direct investments and other assets in which the Fund invests. An investment in the Fund involves a high degree of risk, including the risk that the Shareholder’s entire investment may be lost. The Fund’s performance depends upon the Adviser’s selection of Investment Funds and direct investments in operating companies, the allocation of offering proceeds thereto, and the performance of the Investment Funds, direct investments, and other assets. The Investment Funds’ investment activities and investments in operating companies involve the risks associated with private equity investments generally. Risks include adverse changes in national or international economic conditions, adverse local market conditions, the financial conditions of portfolio companies, changes in the availability or terms of financing, changes in interest rates, exchange rates, corporate tax rates and other operating expenses, environmental laws and regulations, and other governmental rules and fiscal policies, energy prices, changes in the relative popularity of certain industries or the availability of purchasers to acquire companies, and dependence on cash flow, as well as acts of God, uninsurable losses, war, terrorism, earthquakes, hurricanes or floods and other factors which are beyond the control of the Fund or the Investment Funds. Unexpected volatility or lack of liquidity, such as the general market conditions that prevailed in 2008, could impair the Fund’s performance and result in its suffering losses. The value of the Fund’s total net assets is expected to fluctuate. To the extent that the Fund’s portfolio is concentrated in securities of a single issuer or issuers in a single sector, the investment risk may be increased. The Fund’s or an Investment Fund’s use of leverage is likely to cause the Fund’s average net assets to appreciate or depreciate at a greater rate than if leverage were not used.

The Fund is a non-diversified, closed-end management investment company with limited performance history that a Shareholder can use to evaluate the Fund’s investment performance. The Fund may be unable to raise substantial capital, which could result in the Fund being unable to structure its investment portfolio as anticipated, and the returns achieved on these investments may be reduced as a result of allocating all of the Fund’s expenses over a smaller asset base. The initial operating expenses for a new fund, including start-up costs, which may be significant, may be higher than the expenses of an established fund. The Investment Funds may, in some cases, be newly organized with limited operating histories upon which to evaluate their performance. As such, the ability of the Adviser to evaluate past performance or to validate the investment strategies of such Investment Funds will be limited. In addition, the Adviser has not previously managed the assets of a closed-end registered investment company.

Closed-End Fund; Liquidity Risks: The Fund is a non-diversified closed-end management investment company designed principally for long-term investors and is not intended to be a trading vehicle. An investor should not invest in the Fund if the investor needs a liquid investment. Closed-end funds differ from open-end management investment companies (commonly known as mutual funds) in that investors in a closed-end fund do not have the right to redeem their shares on a daily basis at a price based on net asset value.

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Risks of investing and important disclosures

1 The MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets. The MSCI World Index consists of the following 23 developed market country indexes: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the United Kingdom, and the United States. (https://www.msci.com/world) while Pomona’ focuses on primarily purchasing secondary interests in private equity funds. The MSCI World Index has not been selected to represent an appropriate benchmark to compare an investor’s performance, but rather is shown as a comparison to that of a well-known and widely recognized index. The MSCI World Index is not subject to any of the fees and expenses to which any Pomona fund would be subject and no fund sponsored by Pomona Capital will attempt to replicate the performance of the MSCI World Index.

2 The Cambridge Secondary Funds Index is based on unaudited quarterly performance data compiled from 334 secondary funds (excluding hard assets funds), including fully liquidated partnerships, formed between 1991 and 2023. The index has limitations (some of which are typical to other widely used indices) and cannot be used to predict performance of the Fund. These limitations include: 1. Survivorship bias (the returns of the index may not be representative of all secondary funds in the universe because of the tendency of lower performing funds to not report returns to the index); 2. Lack of transparency (the specific funds that are included in this index are not disclosed by Cambridge Associates, and therefore cannot be independently verified); 3. Heterogeneity (not all secondary funds are alike or comparable to one another, and the index may not accurately reflect the performance of a described style); and 4. Limited data (many funds do not report to indices, and the index may omit funds, the inclusion of which might significantly affect the performance shown).

The index does not represent the Fund’s performance, and has not been selected to represent an appropriate benchmark to compare an investor’s performance, but rather is provided to allow for comparison to that of certain well-known and widely recognized indices. Further, as Cambridge Associates recalculates the index each time a new fund is added, the historical performance of this index is not fixed, cannot be replicated, and differs over time from the data presented in this communication. See Cambridge Associates for a complete explanation on IRR calculations and assumptions.

The investments within Pomona Investment Fund and the corresponding performance volatility thereof may differ significantly from the securities and or funds that comprise the Cambridge Index, which may contain strategies and asset types Pomona does not utilize. The Cambridge Index is not subject to any of the fees and expenses to which Pomona Investment Fund would be subject and no fund sponsored by Pomona Capital will attempt to replicate the performance of the Cambridge Index. Pomona does not pay any fees to Cambridge Associates to be ranked.

3 The S&P 500 Index measures the value of stocks of the 500 largest corporations by market capitalization listed on the New York Stock Exchange or Nasdaq Composite. Standard & Poor’s intention is to have a price that provides a quick look at the stock market and economy. The composite performance of the S&P 500 is shown strictly for the purpose of comparison between the performance information contained herein and these popular public equity market indices. The S&P 500 is a widely recognized, unmanaged index of market activity based upon the aggregate performance of a selected portfolio of publicly traded common stocks.

The performance of the S&P 500 shown in this document reflects the reinvestment of dividends and other distributions. In addition, the S&P 500 shown in this document is not subject to any of the fees and expenses to which any Pomona-sponsored fund would be subject. The S&P 500 has been selected as a general indicator of market health despite the lack of similarity of its underlying components to Pomona-sponsored funds. The S&P 500 index is not subject to any of the fees and expenses to which any Pomona fund would be subject to; Pomona-sponsored funds will invest in other market investment vehicles and will not attempt to replicate the performance of the S&P 500. http:// us.spindices.com/indices/equity/sp-500.

4 Cambridge Associates LLC U.S. Private Equity: The index is a horizon calculation based on data compiled from 2,755 US private equity funds, including fully liquidated partnerships, formed between 1986 and 2023. The investments within a private equity fund and the corresponding performance volatility thereof may differ significantly from the securities that comprise the index, which may contain strategies and asset types a private equity fund does not utilize. The index is calculated on an annualized total return basis with dividends reinvested. The index has not been selected to represent an appropriate benchmark to compare an investor’s performance, but rather is shown as a comparison to that of a wellknown and widely recognized index. The index is not subject to any of the fees and expenses to which any private equity fund would be subject and no private equity fund will attempt to replicate the performance of the index.

5 The Bloomberg US Aggregate Bond Index measures the performance of the US investment-grade fixed-rate taxable bond market, which includes the following types of securities and typically only includes securities that have $300 million or more of outstanding face value and at least one year remaining to maturity: investment-grade US Treasury bonds, government-related bonds, investment-grade corporate bonds, mortgage passthrough securities, commercial mortgage-backed securities and asset-backed securities that are publicly offered for sale in the U.S. The investments within a private equity fund and the corresponding performance volatility thereof may differ significantly from the securities that comprise the index, which may contain strategies and asset types a private equity fund does not utilize. The index is calculated on a total return basis. The index has not been selected to represent an appropriate benchmark to compare an investor’s performance, but rather is shown as a comparison to that of a well-known and widely recognized index. The index is not subject to any of the fees and expenses to which any private equity fund would be subject and no private equity fund will attempt to replicate the performance of the index

Past performance is no guarantee of future results. There are no guarantees a diversified portfolio will outperform a non-diversified portfolio. Diversification does not guarantee a profit or ensure against loss. Private equity may not be suitable for every investor, may involve a high degree of risk, and may be appropriate investments only for sophisticated investors who are capable of understanding and assuming the risks involved. Private equity investments are subject to various risks. These risks are generally related to: (i) the ability of the manager to select and manage successful investment opportunities; (ii) the quality of the management of each company in which a private equity fund invests; (iii) the ability of a private equity fund to liquidate its investments; and (iv) general economic conditions. Private equity funds that focus on buyouts have generally been dependent on the availability of debt or equity financing to fund the acquisitions of their investments. Depending on market conditions, however, the availability of such financing may be reduced dramatically, limiting the ability of such private equity funds to obtain the required financing or reducing their expected rate of return. Private equity funds, as well as securities that invest in such funds and companies in which such funds or securities may invest, tend to lack the liquidity associated with the securities of publicly traded companies and as a result are inherently more speculative.

All equity investing involves risks of fluctuating prices and the uncertainties of rates of return and yield inherent in investing. Stock of an issuer in a fund’s portfolio may decline in price if the issuer fails to make anticipated dividend payments because, among other reasons, the issuer of the security experiences a decline in its financial condition. Securities of small and mid-sized companies may entail greater price volatility and less liquidity than investing in stocks of larger companies.

This information is proprietary and cannot be reproduced or distributed. Certain information may be received from sources Voya Investment Management (“Voya IM”) considers reliable; Voya IM does not represent that such information is accurate or complete. Certain statements contained herein may constitute “projections,” “forecasts” and other “forward-looking statements” which do not reflect actual results and are based primarily upon applying retroactively a hypothetical set of assumptions to certain historical financial data. Actual results, performance or event may differ materially from those in such statements. Any opinions, projections, forecasts and forward-looking statements presented herein are valid only as of the date of this document and are subject to change. Nothing contained herein should be construed as (i) an offer to buy any security or (ii) a recommendation as to the advisability of investing in, purchasing or selling any security. Voya IM assumes no obligation to update any forward-looking information.