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CAIA Level II: Advanced Core Topics in Alternative Investments, 2nd Edition by CAIA Association

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CHAPTER 14

The Management of Liquidity*

Investments in private equity (PE) funds have proved to be risky for a number of reasons, but principally because of the long duration of the exposure and the lack of liquidity. Managing the liquidity of a private equity fund investment program needs to take into account the existing interdependencies among the overall investment strategy, the management of the undrawn capital, and the available resources and aspects of timing. It is a difficult task to put money efficiently to work while maintaining a balance in the portfolio composition and the quality of the individual fund investments. Therefore, modeling the cash flows of such investments is an important part of the management process and potentially allows one to do the following:

  • Improve investment returns for the undrawn capital
  • Increase the profit generated by the private equity allocation through overcommitment
  • Calculate an economic value when a discount rate is available
  • Monitor the cash flows and risk-return profiles of a portfolio of private equity funds

Achieving a high total return for the overall investment program is a complex task that requires not only quantitative modeling and financial engineering skills but also a high degree of judgment and management discipline. There is no quick fix for this, and only a disciplined approach can deliver small improvements that eventually add up to a significant impact. As a result, it is likely to take many years before an investment ...

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