Reading 1.7 Flashcards
Efficiency drag or Cash drag?
When the committed (uncalled) capital is called upon in tranches over several years
Among the three Private Real Estate, Private Equity, Private Debt which was called upon in the shortest and longest amount of time?
The most quick: Private RE
Then Private debt
Private equity
Suppose called capital invested in a private fund generated 15% annual IRR and committed capital invested in cash yielded 0%.
After eight years, a private debt or private real estate investor’s return on committed capital would be ____ basis points (bps) lower than the private investment’s IRR, and a PE investor’s return would be ____ bps per year lower.
1) 360
2) 525
How much average capital is called after 3 years? How stable is the figure?
66%
Very stable, not related to the economic cycle
How diversifiable are capital call?
When there is a larger amount of managers the range on the amount called is reduced, but still no less than 25% variability
Possible solution to Capital Drag?
Focus on investment vehicles that deploy capital quicker
Why is diversifying the call risk difficult?
- Minimum investment requirements for most funds
- size of illiquid allocations
- number of vintages active in a strategic asset allocation
- number of managers needed to diversify the risk in each vintage
Describe strategy of Investing uncalled capital in PME? When does it work well?
The strategy is used to invest the uncalled capital into a PUBLIC MARKET EQUIVALENT
Works best in an environment of positive returns
Liquidity tearing framework, 3 strategies
- The first tier consists of calls expected over the next year, which are held in active ultrashort investments with durations of less than one year.
- The second tier consists of calls expected in the second and third years, held in slightly higher-risk (and higher-return potential) fixed income with a matching investment horizon.
- The third tier consists of all remaining calls, which are held in PME assets.
Each year after the initial allocation, the remaining asset allocation (i.e., percentage of original commitment) declines as does the average call rate.
Liquidity tearing framework potential benefits
• Investors with tiered liquidity inherently align their assets with their liabilities.
• In market drawdowns, immediate funding needs can be fulfilled by low-risk ultrashort fixed-income assets, allowing for potential future recovery in the portfolio’s higher-returning portions.
• In appreciating/positive markets, the higher tiers should grow relative to the remaining uncalled capital, allowing investors to capture more upside when it is less risky.
Using private equity generates similar returns to ____ despite PE’s slower call schedule and thus longer management of committed capital
Private Debt
4 liquidity Management Strategies
- Ultra-conservative approach - investor holds all committed capital in a money market/ T-bill-style investment.
- Riskiest approach - investor allocates all committed capital to the PME (i.e., high-yield debt in this case).
- Application of tiering approach based on average call rates
- More conservative application of tiering approach - tiers for the highest 10th percentile of call rates each year.
Expected shortfall
Average difference between the portfolio’s value and the remaining uncalled capital when the former is less than the latter
Dynamically managing portfolio’s upcoming calls results in?
Considerably higher gains than cash with less risk than a PME investment
Benefit of tiering
Investors have the potential to capture much of the right tail upside of PME while limiting their downside exposure
