Investments in private equity

Institutional investors provide private equity capital in the hopes of achieving risk adjusted returns that exceed those possible in the public equity markets and will typically include private equity as part of a broad asset allocation that includes traditional assets (e.g., public equity and bonds). Most institutional investors, do not invest directly in privately held companies, lacking the expertise and resources necessary to structure and monitor the investment. Instead, institutional investors will invest indirectly through a private equity fund. Certain institutional investors have the scale necessary to develop a diversified portfolio of private equity funds themselves, while others will invest through a fund of funds to allow a portfolio more diversified than one a single investor could construct.
Private equity firms generally receive a return on their investments through one of the following avenues:
an Initial Public Offering (IPO) - shares of the company are offered to the public, typically providing an partial immediate realization to the financial sponsor as well as a public market into which it can later sell additional shares;
a merger or acquisition - the company is sold for either cash or shares in another company;
a Recapitalization - cash is distributed to the shareholders (in this case the financial sponsor) and its private equity funds either from cash flow generated by the company or through raising debt or other securities to fund the distribution.