not much higher than 1.0. Once again, some investors do have weights on private equity as high as this, but they are usually investors with extensive experience in private equity. For higher weights on private equity, there is a high degree of sensitivity to the true parameters. For w = 50% and B up to 1.5, total volatility of the equity portfolio increases by a factor of up to 1.5. An investor who chooses to put 50 percent of her total equity portfolio in private equity must be very confident that she can control the risk and return profile of the private equity portfolio. Otherwise, it is very possible to incur a significant volatility penalty without a corresponding increase in return. KEY IDEAS____________________________________ The key ideas in this chapter are the following: 11 Private equity differs from public equity in several ways: 1.    In private equity, information does not flow freely. 2.    Private equity is highly illiquid. 3.    Transaction costs are high. II These factors create the opportunity (but not a guarantee) for higher returns. II The same factors cause private equity valuations, and resulting returns statistics, to be unreliable. 11 Available data on internal rate of return generated by private equity partnerships suggest that median rates of return are roughly comparable to the public equity market, but dispersion among fund managers is much higher than in the public market. II As a result, the risk and return in any private equity portfolio depend very strongly on how that portfolio is constructed-estimates for private equity as a class are of limited utility. II We suggest that private equity can be modeled as having a mixture of characteristics that depend on equilibrium returns in the public equity market, and on nonequilibrium non-public-market factors. II Using a simple two-asset model, we show that simple diversification is usually an inadequate rationale for investing in private equity-these investments only make sense when there is a reasonable likelihood of additional return due to superior information or skill on the part of the private equity manager. II In order to invest successfully in private equity, great care must be taken to understand the underlying sources of risk and return in the selected private equity investment. 11 For specific returns (alpha) of at least 3 percent, and beta no greater than 1.5, it may be optimal to allocate at least 10 percent of the total equity portfolio to private equity, and possibly as much as 50 percent of the total equity portfolio. II Allocations toward the lower end of this range have only modest penalties for suboptimal allocations, in the event that the parameter estimates that are used turn out to be incorrect. However, the penalties increase markedly toward the high end of the range.