We use a proprietary database of private equity returns to measure the excess return of private equity over public equity and to partition it into two components: an asset class alpha and compensation for illiquidity. Our evidence suggests that private equity managers, as a group, generate alpha by anticipating the relative performance of economic sectors. If we assume that manager‐specific alpha is fully diluted across a broad universe of private equity managers, we can interpret the balance of excess return as a premium for illiquidity. This result suggests that investors can capture the asset class alpha of private equity by using liquid assets such as ETFs to match the sector weights of private equity investors. This decomposition of private equity performance has important implications for portfolio choice, which we explore in this paper.