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Optimal Commitment Pacing

It would not be an exaggeration to say that illiquidity is not a risk in a typical private equity portfolio—it is a certainty. That is because, unlike investments in the public markets, private equity investments cannot be readily bought or sold. Investors must therefore factor private equity’s illiquidity into their plans, including the pace of commitments designed to achieve an asset allocation on target. For most institutional investors, the most economical way to achieve a particular asset allocation is by managing the annual commitment policy to new investments. Thus, most institutional investors can benefit from a better understanding of the relationship between current and planned commitments and private equity allocation.

Alignment Capital Group believes that a thoughtful policy for planning commitments over time is necessary to managing the likelihood of an under-allocation or over-allocation to private equity within the total investment portfolio.

ACG has developed cash flow and valuation forecasting methodologies and models that allow the client to choose the best commitment policy for reaching its goals. ACG performs regular commitment reviews for each client to ensure that the commitment recommendation includes the latest information.

Commitment pacing studies are customized to each client in order to ensure that the an optimal investment decision. Specifically, the process considers the client’s investment strategy and the seasoning of the client’s current portfolio in order to project the expected behavior of those existing investments into the future. Based on the statistical distribution of the future valuation of the client’s existing portfolio, ACG recommends the appropriate timing and weighting of future commitments in order to keep the portfolio at or near its target allocation.

Note, in this context, that there is often a tradeoff between the need for temporal diversification (the need to invest over time, rather than in a single year, so as not to risk concentrated investment into a single substandard vintage) and the desire to reach a target asset allocation as quickly as possible. In order to make an optimal decision, it is critical to understand the minimum number of vintages required to reduce temporal risk. ACG’s proprietary statistical tools and techniques are designed to determine and weigh the risks associated with temporal concentration of investments.

For the client, the result is a systematic approach to a program of private equity commitments that minimizes the expected variation of the private equity allocation around its target.

Example: Optimal Commitment Pacing