Building a Better Portfolio: Balancing Performance and Liquidity

Investors have been increasing their allocations to private assets seeking higher returns and better portfolio diversification. However, as this allocation increases, the liquidity characteristics of their portfolios change. To address this issue we create a framework that links bottom-up private asset investing with top-down asset allocation. Private asset cash flows are consistently modeled together with public asset returns and risk that, in turn, drive portfolio construction. This helps investors analyze how allocations to illiquid private assets, in combination with their commitment strategy, may affect their portfolio’s ability to respond to various liquidity demands. By measuring the potential tradeoff between asset allocations, total portfolio performance and the frequency of certain liquidity events with different severities, this framework can help investors quantify the interaction between their portfolio structure and performance, and formalize their decision making around portfolio liquidity choices.