Reading 1.7

Question 1

Efficiency drag or Cash drag?

Answer 1

When the committed (uncalled) capital is called upon in tranches over several years

Question 2

Among the three Private Real Estate, Private Equity, Private Debt which was called upon in the shortest and longest amount of time?

Answer 2

The most quick: Private RE
Then Private debt
Private equity

Question 3

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.

Answer 3

1) 360

2) 525

Question 4

How much average capital is called after 3 years? How stable is the figure?

Answer 4

66%

Very stable, not related to the economic cycle

Question 5

How diversifiable are capital call?

Answer 5

When there is a larger amount of managers the range on the amount called is reduced, but still no less than 25% variability

Question 6

Possible solution to Capital Drag?

Answer 6

Focus on investment vehicles that deploy capital quicker

Question 7

Why is diversifying the call risk difficult?

Answer 7

• 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

Question 8

Describe strategy of Investing uncalled capital in PME? When does it work well?

Answer 8

The strategy is used to invest the uncalled capital into a PUBLIC MARKET EQUIVALENT

Works best in an environment of positive returns

Question 9

Liquidity tearing framework, 3 strategies

Answer 9

1. 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.
2. 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.
3. 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.

Question 10

Liquidity tearing framework potential benefits

Answer 10

• 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.

Question 11

Using private equity generates similar returns to ____ despite PE’s slower call schedule and thus longer management of committed capital

Answer 11

Private Debt

Question 12

4 liquidity Management Strategies

Answer 12

1. Ultra-conservative approach - investor holds all committed capital in a money market/ T-bill-style investment.
2. Riskiest approach - investor allocates all committed capital to the PME (i.e., high-yield debt in this case).
3. Application of tiering approach based on average call rates
4. More conservative application of tiering approach - tiers for the highest 10th percentile of call rates each year.

Question 13

Expected shortfall

Answer 13

Average difference between the portfolio’s value and the remaining uncalled capital when the former is less than the latter

Question 14

Dynamically managing portfolio’s upcoming calls results in?

Answer 14

Considerably higher gains than cash with less risk than a PME investment

Question 15

Benefit of tiering

Answer 15

Investors have the potential to capture much of the right tail upside of PME while limiting their downside exposure

Question 16

Why is tiering beneficial?

Answer 16

• Assets’ investment horizon is more closely matched to the timing of the anticipated liabilities.

• In down markets, the size of the highest-risk tiers shrink and allow the portfolio to minimize losses.

• Liquidity tiering allows investors to thoughtfully invest their uncalled capital commitments

Question 17

Risks of over-committing

Answer 17

• Amount of capital deployed by a private investment fund (and thus amount of capital called) early in its life is uncertain.

• There is substantial dispersion in realized calls (even in a portfolio of managers is used for diversification purposes).

Question 18

Overcommitting

Answer 18

Committing more capital than is immediately available with the expectation that additional funds will become available as needed in the future.