Private Markets Have a Diversification Problem. Can CFOs Help Investors Manage Risk?

Private markets have transformed from a niche corner of institutional finance into a core portfolio allocation. Global private capital assets under management ballooned to nearly $13.8 trillion by the end of 2024 from $3 trillion in 2010. Yet alongside this growth sits a persistent challenge: Private markets are illiquid, opaque, and difficult to diversify efficiently.

In an April 2026 white paper, “Beyond the Blind Pool: How Private Asset-Backed Structures Reshape Risk and Return,” a team of researchers examined a potential solution: collateralized fund obligations, or CFOs. They analyzed whether these structured vehicles can genuinely deliver on their promise.

The paper is organized around three questions:

• What makes private market assets structurally different from public ones, and how does that shape their risk and return?
• How far can diversification alone take an investor in reducing private market risk?
• Can structured products like CFOs overcome the limitations that diversification cannot?

The authors draw on historical fund-level cash flow data from Preqin, simulation frameworks from prior academic work, and real-world examples—most notably the Astrea 9 CFO transaction launched in 2025 by Azalea Asset Management. They also synthesize a wide body of academic literature on private equity performance, manager selection, and securitization.

The Structural Realities of Private Markets

The paper begins by cataloging what makes private assets distinctive. Illiquidity is the most obvious feature: Buyout fund capital is typically locked up for around 14 years, venture capital for 15.

Cash flows are lumpy and unpredictable, following the familiar J-curve: negative early on as capital is drawn down, then positive as portfolio companies are exited.

Leverage amplifies returns in buyouts but also magnifies losses.

Reporting is infrequent and nonstandardized, creating stale pricing that artificially smooths reported volatility and complicates risk measurement.

Perhaps most consequentially, manager selection matters enormously. Over the decade ending December 2024, the gap between a top-quartile and median private equity manager was 9.32 percentage points per year compared with less than 1 percentage point for global large-cap equity funds. To make matters harder, performance persistence among buyout managers has eroded: Only 24% repeated top-quartile performance after 2001, down from 37% before.

Despite these challenges, the evidence on returns is encouraging. Across vintages from 2007 to 2021, private equity funds outperformed the MSCI World Index in all but two years, with an average Kaplan-Schoar public market equivalent of 1.17—meaning private equity investors received 17% more than they would have earned investing the same cash in a global equity index.

The Limits of Diversification

The paper devotes substantial attention to how diversification works in practice—and where it breaks down. Running thousands of portfolio simulations, the authors show that spreading commitments across more funds, more strategies, more vintage years, more sectors, and more geographies each reduces idiosyncratic risk meaningfully. Return dispersion narrows as portfolio size grows from one to 25 funds, and vintage year correlations turn negative for funds formed four or more years apart, creating natural hedges.

The authors concluded, “Diversification is theoretically desirable, but achieving deep, multidimensional diversification in private markets can be operationally burdensome and capital-intensive.”

Note that there is actually a simple and elegant solution to the burdens cited: Avoid the use of proprietary funds. Proprietary funds like those of Blackstone, Apollo, Ares, and KKR invest capital into their own proprietary strategies.

The burdens of due diligence, monitoring, and reporting associated with maintaining a large set of primary fund relationships can be eliminated by allocating to private assets through open architecture funds. Open architecture platforms select third-party managers with strong performance histories as partners and invest in their originated product rather than originating, warehousing, or sponsoring the assets itself. These funds minimize idiosyncratic risk by diversifying across managers, sectors, geography, and fund vintage (through the use of secondaries). The leading open architecture firms include Cliffwater, Stepstone, Hamilton Lane, and Calamos Aksia.

What Diversification Cannot Do

The paper is equally clear about what diversification cannot do. It cannot eliminate macroeconomic risk as strategies remain exposed to broad economic forces such as interest rate cycles, credit availability, and exit market conditions. For example, during the global financial crisis, distributions across all private market strategies fell to less than 2% of their prior NAVs simultaneously. And if using proprietary funds, diversification faces diminishing returns beyond around 25 funds, while costs keep accumulating.

In addition, the illiquid nature of private equity means investors cannot rebalance tactically the way they can in public markets.

Enter the CFO: Structure and Mechanics

This is where collateralized fund obligations enter the picture. A CFO places a pool of limited partner interests in private funds into a special purpose vehicle (typically referred to as an Asset HoldCo, which owns the portfolio on behalf of the CFO structure), which then issues tranched securities—senior notes, mezzanine notes, and equity—each with a different position in the payment waterfall. Senior noteholders are paid first and bear the least risk; equityholders are paid last and absorb first losses but capture the residual upside.

CFO Capital Structure

Senior notes

Paid first; protected by subordination below. Behavior analogous to investment-grade credit.

Lowest risk

Mezzanine notes

Paid after senior; carry a stated coupon but assume more collateral risk.

Moderate risk

Equity tranche

Receives all residual cash; leveraged exposure to underlying portfolio performance.

Highest risk

The structure offers several concrete benefits. Diversification is engineered into the collateral pool. Rating agencies like Fitch and KBRA explicitly require it as a condition for investment-grade ratings. Cash flows are smoother because vintage-diverse underlying funds are at different points in their J-curves, with older assets distributing while younger ones mature. Insurers and other regulated investors can hold senior CFO notes with lower regulatory capital charges than direct fund commitments. And the weighted average cost of capital for the overall structure falls because cheaper debt replaces some of the expensive equity that would otherwise be needed.

The paper’s simulation analysis quantifies the leverage effect on equity tranche holders. Underlying diversified portfolios in the simulations generated an average total value to paid-in capital of 1.77x. After applying a CFO structure (60% debt, 40% equity), the equity tranche averaged a TVPI of 2.39x—an uplift of 0.62x—but with standard deviation nearly 2.5 times wider than the underlying portfolio. This is the essential bargain of junior CFO tranches: more upside, more downside.

Key Findings

Private equity has consistently outperformed public markets on a cash-flow-equivalent basis, though dispersion across managers and vintages is wide enough that portfolio construction decisions dominate outcomes.

On diversification, private equity works, but its benefits plateau while its costs do not, and it cannot eliminate systemic risk.

CFOs translate existing diversification in a private asset portfolio into differentiated, tradable securities, but their performance depends critically on collateral quality, structural design, and manager expertise.

Finally, the regulatory environment is becoming more hospitable: In 2024, both the US and the UK updated frameworks in ways that may ease insurance capital’s access to these structures.

Key Investor Takeaways

What investors should know:

• Manager selection remains paramount. The gap between top-quartile and median private equity managers is larger than the equivalent in public markets, and performance persistence has declined. Diversification cannot substitute for access to strong general partners.
• Diversify across multiple dimensions, not just the number of funds. Vintage year, strategy, geography, and sector each contribute independently to risk reduction. Concentrating in a single vintage year exposes investors to a shared macro “cohort” risk that cuts across all funds formed in those years.
• Recognize diversification’s limits. Beyond roughly 25 funds, incremental diversification benefits are modest while costs keep rising. Systemic downturns will still hurt broadly diversified private portfolios, as the global financial crisis demonstrated.
• Senior CFO notes offer a genuinely different risk/reward profile. Historical data shows investment-grade tranches defaulting at rates far below equivalent corporate bonds. If CFOs can achieve similar collateral quality, senior notes may appeal to credit allocators, insurers, and liability-matching investors seeking a yield premium over traditional investment-grade bonds.
• Equity tranches amplify, not just transform, underlying private market risk. The structural leverage of a CFO materially lifts expected equity returns—the simulations show a 0.62x TVPI uplift—but also substantially widens the dispersion of outcomes. This is leveraged private equity exposure, not a free lunch.
• Collateral quality determines everything. Secondary fund interests are increasingly preferred as CFO collateral because they return capital faster, strengthening coverage ratios and supporting rating outcomes. Investors should scrutinize the composition of the underlying pool—not just the tranche they are buying into.
• Regulatory tailwinds are real but not permanent. Recent regulatory developments make it easier for insurers to hold senior CFO notes under favorable capital treatment. These rules continue to evolve, and a reversal or tightening could materially affect investor demand and deal economics.
• CFOs are a complement to private market portfolio construction, not a substitute for it. The authors are explicit: Outcomes depend on manager experience, collateral selection, structural design, and sponsor alignment. Without robust execution, the theoretical advantages of securitization may not materialize.
• The burdens of multiple manager selection can be eliminated through investment in open architecture vehicles.

CFOs are neither a panacea for the structural challenges of private market investing nor a repackaged version of the precrisis mortgage securities that attracted so much deserved skepticism. Used well, with experienced managers and appropriate governance, they represent a genuinely useful tool for redistributing private market risk—making access more efficient for some investors and creating clearer risk-return exposures for others.

As private markets continue to scale, and as regulatory frameworks gradually catch up, the role of these structures seems likely to grow.