Financial advisors are increasingly incorporating private market investments into client portfolios, drawn by their apparent diversification benefits and attractive risk-adjusted returns. However, using published private equity returns in portfolio modeling and financial planning without proper adjustments can lead to flawed assumptions about risk and return expectations.
The Smoothing Deception
Private assets are valued at various points in time — marked to valuation rather than marked to market like publicly traded securities. This creates what's known as "performance smoothing," where strategic timing of valuations or specific valuation methodologies can lead to artificially low volatility and lagged reactions to moves in public markets.
The numbers tell a stark story. While the Pitchbook Private Capital Private Equity Index shows an annualized volatility of around 9.7%, desmoothing techniques of this particular index reveal the volatility to be approximately 19%1 — nearly identical to small and mid-cap public equities.
The Desmoothing Imperative
When private equity returns are desmoothed and delagged to reflect market reality, the diversification story changes. Correlation with public equities increases from 0.3 to 0.9. This means private equity behaves much more like leveraged public equity than the alternative investment it appears to be on paper. For asset allocation, this has profound implications. A portfolio integrating private equity may inherently resemble a higher allocation in terms of equity risk characteristics than its historical returns imply, defeating the purpose of seeking diversification. This is in addition to the liquidity risk typically compensated for with a premium on private equity returns.
Using smoothed returns also dramatically underestimates economic growth factor exposure. Private equity's concentrated portfolios of leveraged, growth-oriented companies create significant factor tilts that smoothed returns obscure. Financial advisors relying on published returns may unknowingly concentrate client portfolios in growth factors beyond levels intended for a given risk capacity. Ultimately the investor needs to know the exposure of the underlying holdings within a private equity allocation to fully assess portfolio diversification benefits.
Dispersion Reality
The dispersion of private equity returns between top and bottom quartile managers is significantly wider than in liquid asset classes, with the average difference being documented between 10% and 15%.2 This isn't necessarily evidence of manager skill and luck but also reflects the mathematics of concentrated, leveraged portfolios in small companies. Research shows this dispersion can be fully replicated through concentrated portfolios of cheap, leveraged micro-cap public stocks.3
Practical Recommendations
Financial advisors should adjust their portfolio modeling by desmoothing private market returns or using higher volatility assumptions that better reflect economic reality. Consider private equity's true relationship with economic growth and public equity markets when calculating portfolio risk.
The allure of smooth, diversifying returns is tempting, but prudent multi-asset portfolio construction demands acknowledgment of private markets' true risk profile. Only by seeing through the smoothing can advisors make informed allocation decisions that truly serve their clients' long-term interests.
Important Disclosures & Definitions
1 ALPS Advisors Research, 06/04/2025
2 Mulvihill, A. (2025). Guide to alternatives: Quarterly alternatives update Q1 2025. J.P. Morgan Asset Management.
3 Chingono, B., & Rasmussen, D. (n.d.). The dispersion delusion: Private equity's return dispersion is the same as public stocks with similar characteristics. Verdad Capital.
The PitchBook Private Capital Private Equity Index: is a suite of indexes that track the performance of private equity funds across various asset classes, including private equity, venture capital, real estate, and more.
AAI000951 06/10/2026
