Asset Allocation and Private Market Investing

Abstract

Investors have been increasing their allocations to private assets, seeking higher returns and better portfolio diversification. However, as this allocation increases, the liquidity characteristics of their portfolios change. The authors create a framework that links bottom-up private asset investing with top-down asset allocation. Private asset cash flows are consistently modeled together with public asset returns and risk that, in turn, drive portfolio construction. This helps investors analyze how allocations to illiquid private assets, in combination with their commitment strategy, may affect their portfolio’s ability to respond to various liquidity demands. By measuring the potential trade-off among asset allocations, total portfolio performance, and the frequency of certain liquidity events with different severities, this framework can help investors quantify the interaction between their portfolio structure and performance and formalize their decision making around portfolio liquidity choices. <b>TOPICS:</b>Real assets/alternative investments/private equity, portfolio construction, performance measurement, tail risks <b>Key Findings</b> ▪ We present a framework to systematically address various liquidity issues for multi-asset portfolios. ▪ Liquidity requirements have a clear impact on portfolio structure and expected performance. ▪ Commitment pacing of private investments plays a crucial role in the trade-off between liquidity and performance.