Author: Jacobi – jacobistrategies.com
2021 was a record-breaking year for private market deal flow and capital raising, yet the vast majority of investors intend to increase or maintain allocations into the future.1 The need for diversification, as well as higher absolute and relative returns in the current low interest rate environment are factors driving this behaviour. With this increased exposure to, and reliance on private market investments, it is increasingly important that investors manage their position sizes correctly.
Investments into private markets bring with them increased complexity. In our 2018 paper, ‘Modelling Illiquid Assets Within Multi-Asset Portfolios’, we highlighted several unique characteristics of private markets that make managing portfolio allocations more complex – capital calls and capital/income distributions, the interaction of fund size and undrawn commitments (the “denominator” effect), limitations on rebalancing, and building allocations through commitments.
This last consideration – building allocations through commitments – forces investors to balance multiple factors when making an upfront commitment. Over what horizon will the commitment be drawn down? For how long will managers hold investments? How quickly does the investor wish to achieve their target allocation? How will the overall size of the portfolio change? How will currency moves affect the investment Net Asset Value (NAV) relative to portfolio value? What assets will be held to offset the commitment as the investment is being drawn down? How much tolerance is there for overshooting the target allocation?
To date, investors have had to rely on simplified rules to determine the appropriate commitment size (e.g. 1.5x the target allocation), or build complex models in an attempt to answer all those questions listed above. In this paper, we discuss a quantitative approach for sizing commitments to achieve a target allocation to private markets within a multi-asset portfolio. In the rest of this paper we cover:
• Why is a commitment pacing approach required?
• How can the optimal commitment pacing approach be derived?
• Worked examples of commitment pacing in practice
• Limitations and areas for continued improvement
Read the rest of the paper here: https://www.jacobistrategies.com/site/download.html?wpid=23