Private equity’s primary pitch to investors is that it creates value through improving a company’s operations or accelerating growth by easing access to funding. What’s less appreciated, though, is the potential for so-called evergreen strategies to boost returns through how they diversify investors’ portfolios.

Typically, evergreen strategies allow investors to enter and exit periodically, unlike traditional private equity funds that lock in investors’ cash for five or more years. Diversified across a range of private equity investments, they deliver diversification’s main benefit of spreading risk, memorably described by Nobel Prize laureate Harry Markowitz as the only free lunch in investing.

Far less appreciated but potentially just as significant is that an evergreen strategy can also create value through shrewd diversification, amplifying returns. It does so by allocating assets to the most promising underlying private equity investments, in effect turning private equity’s natural information advantage into an investment advantage – what we sometimes call legal inside information.

The managers, or general partners (GPs), of evergreen strategies are constantly in fundraising mode, and as capital flows in, it must be invested. Indeed, when putting capital to work, a GP might make 10 investment decisions a month. That means a GP can direct new capital to where it’s likely to earn the highest returns.

Using diversification to increase investment returns in this way depends on the GP managing the evergreen strategy having a broad and flexible platform. The greater the breadth across geographies, sectors and stages of private equity investing, the greater the scope for returns.

Global trade and tariffs

Taking a topical example, now is an uncertain time for global trade that may have winners and losers, depending on geography. With the U.S. administration introducing widespread tariffs and a chance that the U.S. dollar may decline for a prolonged time, some businesses are in a better position than others. A GP with a platform spanning Asia, Europe and the U.S. can focus on the companies least likely to be affected by tariffs, or those poised to gain from falls in the dollar, such as domestic Vietnamese manufacturers.

Turning to diversification across the stages of a company’s life, a GP with funds focusing variously on buyouts of larger businesses, early-stage businesses and young venture capital companies not only potentially gains from spreading risk but, again, has more options for value-adding diversification. Like different types of wine producers, buyout and venture capital funds tend to have good and bad vintage years. A GP with a platform including all these life stages steers capital towards those currently offering the best vintages.

When managing evergreen strategies, GPs have the luxury of time and timing, which helps them use active diversification and asset allocation particularly effectively. Let me explain. Turning first to timing, public market investors have a reputation for being bad at timing; if emotion influences their trading decisions, they might buy high and sell low. By contrast, in private equity, decisions on when to buy and sell are made by a veteran specialist in a particular industry – for example, French healthcare. This is likely to lead to a better process.

PE’s long-term approach

Regarding time, private equity takes a long-term approach that serves it well. At times of stress like the 2008-2009 global financial crisis (GFC), many public market investors run for the hills. By contrast, private equity can sit back, stay the course and wait for things to get better. That’s a huge part of value creation. Typically, private equity funds pursue avenues for growth over several years and do not let financial turbulence derail their plans.

However, while evergreen strategies are ideal for individual investors, they are not for everyone. For sophisticated institutional investors, the flipside of tactical diversification’s benefits is a loss of control. A GP might aim to invest 50 percent of an evergreen strategy in Europe and 30 percent in the U.S., for example, and then add to healthcare over the years as opportunities come available. But an investor such as a family office or bank might want to make asset allocation decisions itself, buying specialist funds, especially if it has analysts equipped to do so.

Even so, the evergreen strategy’s information advantage, plus the luxury of time and timing, naturally helps it to diversify assets in ways that boost returns. Quite simply, a GP is likely to make sound allocation decisions based on long-term views.

The number of evergreen strategies is growing fast due to their flexible entry and exit terms. As they do so, their potential for creating value through diversification may soon be more widely understood. However, their ability to enhance returns depends on the breadth and flexibility of the GP’s underlying investment platform – not all private markets platforms are equal.