Cash for Calls: A Quantitative Approach to Managing Liquidity for Capital Calls
EXECUTIVE SUMMARY
- Studies of private market investments tend to focus on the return premium associated with illiquid assets and their appeal relative to traditional public market assets. Far less attention is paid to the need for investors in these assets to earmark liquid funds for the capital calls endemic to private market investing – and, importantly, the resulting drag on total returns.
- Solving for the liquid allocation to complement a pending private market investment can be challenging: The speed and magnitude of realized calls are likely to be correlated – sometimes highly correlated – with financial market movements.
- We review historical private fund call behavior to evaluate the effectiveness of various liquidity solutions or cash management strategies. The average investor in private funds must manage uncalled capital for several years.
- “Liquidity tiering” has the potential to provide investors with additional returns relative to cash, with less risk than equivalent assets in public markets.
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All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. High yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Equities may decline in value due to both real and perceived general market, economic and industry conditions. Private market investments involve a high degree of risk and prospective investors are advised that these strategies are suitable only for persons of adequate financial means who have no need for liquidity with respect to their investment and who can bear the economic risk, including the possible complete loss, of their investment.
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