The Tradeoff Between Liquidity and Performance: Private Assets in Institutional Portfolios

PGIM Institutional Advisory & Solutions

January 2019


Are investors sacrificing too much portfolio performance in the name of liquidity? Investors may wish to increase allocation to private assets with their potentially greater returns and diversification benefits, but worry that these assets are too illiquid to generate sufficient cash when needed. How can investors measure the tradeoff between liquidity and performance to determine their optimal mix of private and public assets?    

PGIM’s IAS team presents an asset allocation framework that investors can use as a tool to answer this question. Given an investor’s liquidity requirement, or the degree of confidence in meeting future obligations, what is the optimal mix of private and public assets, and what is the optimal allocation across assets within these portfolios? The framework incorporates realistic performance characteristics of private assets, including their unique cash flow profiles and lumpier transaction costs. The framework also allows investors to express views on expected private asset performance and their fund-selection skills.

The framework identifies the optimal asset allocation for an investor’s desired level of confidence. Changes in a portfolio’s expected horizon value given different liquidity requirements capture the tradeoff between liquidity and performance, helping to answer: “How much does it cost to make my portfolio more liquid?” and “Is my portfolio too liquid?”

Portfolio Sensitivity to Changes in Confidence Levels (Liquidity Requirements)