The key decision for many institutional investors is the mix between liquid and illiquid assets, or put differently, public versus private investments. In years past, the choice was not that hard. If you bought illiquid investments, such as private equity, you received higher returns or a liquidity premium. If you did not need the liquidity, this was a great benefit and risk worth taking. Additionally, because the pricing of the illiquid assets was made annually, there was an apparent reduction in volatility in the portfolio. Lower risk, higher return in exchange for giving up some liquidity. But the world has changed.
Private equity returns have declined, so the private or public return premium has compressed. There is a greater awareness that volatility is being masked with private equity. Finally, it is more difficult for the private equity manager to sell their assets, resulting in less liquidity than expected. It will take longer to receive a return on capital, and investors must pay a high price for this illiquidity.
Hence, investors should think about how to formulate public or liquid portfolios with a payoff. Investors need market returns with higher alpha, which can be received through portable means, along with some form of downside protection or volatility smoothing. Since private equity has a very dispersed return pattern. A public structure that provides a mean return seems to be a good bet - average private equity returns with liquidity
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