Mastering Illiquidity: Risk management for portfolios of limited partnership funds

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Translating Fund Grades into Quantification

To value and measure risks for limited partnership funds, we have to overcome a series of problems. The quantitative analysis focuses on the financial strength and on the portfolio. But the relevance of the portfolio analysis follows the fund's lifecycle, with its importance increasing over time. As the investment is usually in a blind pool, any assessment has to rely – at least during the early years of the fund's life – to a high degree on qualitative criteria.

We follow on from the previous chapter and discuss a so-called fund grading system that draws upon analogies from established rating techniques for credit risk. The purpose of this discussion is not an exhaustive description of possible scoring techniques, which can be found in Crouhy et al. (2001) and Meyer and Mathonet (2005); instead, we focus on the question of how fund grades can be translated into a consistent quantification to determine ranges for growth rates as inputs for the cash flow projection models. This grading system comprises two components; that is (i) “expected performance” (P-A, P-B, P-C, P-D) and (ii) “operational status” (O-A, O-B, O-C, O-D) grades. The expected performance is assessed through benchmarking comparable funds with similar characteristics, and by identifying possible weaknesses in the fund's structure. This approach aims to provide a consistent framework for the ex-ante assessment, monitoring and ex-post performance measurement of partnerships. ...