Skip to main content
PGIM LogoPGIM Logo
    • Megatrends
    • Annual Best Ideas
    • Quarterly Market Outlooks
    • Market Events
    • Thought Leadership
    • Events & Webinars
    • ESG Investing
    • Investing in Alternatives
    • Reaching for Yield
    • Clients We Serve
    • Defined Contribution
    • Institutional Relationships
    • Advisory Solutions
    • Global Locations
    • Contact Us
    • Overview
    • Leadership
    • History
    • Inclusion & Diversity
    • Global Locations
    • Jennison Associates
    • PGIM Fixed Income
    • PGIM Private Capital
    • PGIM Real Estate
    • QMA
    • PGIM Investments
    • PGIM Global Partners
    • Contact Us
    • Subscribe
    • Request for Information
    • Careers at PGIM
    • Job Opportunities
    • All News
    • Press Releases
    • In the News
    • Facts & Figures
    • Media Contacts
Modeling Private Investment Cash Flows
Portfolio Construction

Modeling Private Investment Cash Flows with Market-Sensitive Periodic GrowthModelingPrivateInvestmentCashFlowswithMarket-SensitivePeriodicGrowth

By Dr. Vishv Jeet — Oct 30, 2020

8 mins read

Share
  • Mail
  • LinkedIn
  • Twitter
  • Copy URL
Download white paper

Share

Modeling private investment cash flows is an important challenge for investors.  With a cash flow model an investor can simulate possible market scenarios, cash flow shortfalls, and liquidity crises.  Such an analysis can be very useful for CIOs who must make important decisions related to asset allocation and liquidity planning.  

The Takahashi and Alexander’s (TA) framework to model private capital portfolio’s cash flows has stood the test of time.  However, estimating its single lifetime growth parameter remains a challenge.  The single paramater for growth also makes the model cash flows insensitive to short-term movements in the broad market returns.  This is especially problematic in a simulation setting in which market returns are sampled many times.  How might a private investment behave in different market scenarios is an important portfolio management question.  

We explore a modification to the TA model in which a series of periodic growth rates are used to model distributions and valuations.  In a simulation setting these growth rates can be correlated with public market returns via lagged regression of quarterly IRRs on several lags of quarterly public market returns.  This makes the modified model more realistic as the model valuations and distributions become responsive to short-term market movements.  

Using historical simulation on actual market data we show that the modified version of the TA model does a better job modeling actual cash flows, while retaining the spirit of the original TA model.

Comparison of Lifetime and Periodic Growth TA Models

We compare two versions of the TA model: one that uses a single lifetime growth parameter and one that uses a set of periodic growth parameters.  For this comparison we fix all other TA parameters which we calibrate using pooled US buyout data across vintages 1980 through 2020.  We use a bow factor of 4, lifespan of 12y, and rate of contribution 28% in the first year, 25% in the second year and 30% onwards.  

To begin, we first use actual data for the two sets of growth parameters.  For the lifetime growth parameter, we use the actual 12y IRR, when available, and since-inception IRR otherwise, as reported by Burgiss.  For the set of periodic growth parameters, we use actual quarterly IRRs, also from Burgiss.  This exercise provides an “estimation-free” comparison between the two models.  In reality, the value of a cash flow model lies in its predictive power for which we would also have to predict (or, estimate) the growth parameter. 

We compare these two TA model versions using 15 individual consecutive vintages from 2000 to 2014.  Figure 1 shows the cumulative net cash flow, by vintage, generated by each model.  A quick look at Figure 1 may tempt one to conclude that the two models are nearly the same, as the periodic and lifetime growth models’ cumulative cash flows track each other.  Toward the end of 12y lifespan the periodic and lifetime models do start to drift apart as the quarterly IRRs become noisier as valuations gets smaller.  However, since these noisy periodic growth estimates are applied to smaller valuations, the gap between the two models is effectively small.  

We present a modified version of the TA model in which the model’s lifetime growth parameter is replaced with period-specific growth parameters – i.e., a growth parameter for each period.  Periodic growth values are modeled using lagged regression.  The modified TA model provides a systematic way to link private capital growth and distributions to public markets.  We present computational evidence using buyout and public market data to show the usefulness of this modified TA model.

Download white paper
Learn more
INSTITUTIONAL ADVISORY & SOLUTIONS

The IAS team conducts bespoke, quantitative client research that focuses on asset allocation and portfolio analysis.

Learn more

  • By Dr. Vishv JeetVice President, Institutional Advisory & Solutions, PGIM

You may also like

Riders in the Storm
Portfolio Performance & Markets

Riders in the Storm

Jun 21, 2020

This paper examines public and private asset average performance during the VIX spike quarter and in the pre- and post-volatility spike periods.

Measuring the Value of LP Fund-Selection Skill
Manager Allocation

Measuring the Value of LP Fund-Selection Skill

May 3, 2020

Using the IAS fair comparison framework, this publication explores the impact of choices an investor in private markets must make.

The Probability of Recession
Portfolio Performance & Markets

The Probability of Recession

Jun 5, 2020

We evaluate a new recession probability model that depends on economic and market inputs. The model tends to predict economic downturns but not equity declines.

  • Insights

    • Megatrends

    • Annual Best Ideas

    • Quarterly Market Outlooks

    • Market Events

    • Thought Leadership

    • Events & Webinars

  • Investment Themes

    • ESG Investing

    • Investing in Alternatives

    • Reaching for Yield

  • Clients

    • Clients We Serve

    • Defined Contribution

    • Institutional Relationships

    • Advisory Solutions

  • About

    • Overview

    • Leadership

    • History

    • Inclusion & Diversity

    • Global Locations

    • Contact Us

    • Subscribe

    • Request for Information

  • Careers

    • Careers at PGIM

    • Job Opportunities

  • Newsroom

    • All News

    • Press Releases

    • In the News

    • Facts & Figures

    • Media Contacts

PGIM Logo
  • Terms & Conditions
  • Privacy Center
  • Accessibility Help
  • UK Regulatory Disclosures
  • Cookie Preference Center

Prudential Financial, Inc. and its related entities.

For Professional Investors only. All investments involve risk, including the possible loss of capital.

It is for informational and educational purposes only and should not be construed as investment advice or an offer or solicitation in respect of any products or services to any persons who are prohibited from receiving such information under the laws applicable to their place of citizenship, domicile or residence. PGIM, Inc., is the principal asset management business of PFI and is a registered investment advisor with the US Securities and Exchange Commission(SEC). Registration with the SEC does not imply a certain level of skill or training.  PGIM is a trading name of PGIM, Inc and its global subsidiaries.    

In the United Kingdom, information is issued by PGIM Limited with registered office: Grand Buildings, 1-3 Strand, Trafalgar Square, London, WC2N 5HR. PGIM Limited is authorised and regulated by the Financial Conduct Authority (“FCA”) of the United Kingdom (Firm Reference Number 193418). In the European Economic Area (“EEA”), information is issued by PGIM Netherlands B.V. with registered office: Gustav Mahlerlaan 1212, 1081 LA  Amsterdam, The Netherlands. PGIM Netherlands B.V. is, authorised by the Autoriteit Financiële Markten (“AFM”) in the Netherlands (Registration number 15003620) and operating on the basis of a European passport. In certain EEA countries, information is, where permitted, presented by PGIM Limited in reliance of provisions, exemptions or licenses available to PGIM Limited under temporary permission arrangements following the exit of the United Kingdom from the European Union. These materials are issued by PGIM Limited and/or PGIM Netherlands B.V. to persons who are professional clients as defined  under the rules of the FCA and/or to persons who are professional clients as defined in the relevant local implementation of Directive 2014/65/EU (MiFID II).  

In Japan, investment management services are made available by PGIM Japan, Co. Ltd., ("PGIM Japan"), a registered Financial Instruments Business Operator with the Financial Services Agency of Japan. In Hong Kong, information is provided by PGIM (Hong Kong) Limited, a regulated entity with the Securities & Futures Commission in Hong Kong to professional investors as defined in Section 1 of Part 1 of Schedule 1 (paragraph (a) to (i) of the Securities and Futures Ordinance (Cap.571). In Singapore, information is issued by PGIM (Singapore) Pte. Ltd. (“PGIM Singapore”), a Singapore investment manager that is licensed as a capital markets service license holder by the Monetary Authority of Singapore and an exempt financial adviser. These materials are issued by PGIM Singapore for the general information of “institutional investors” pursuant to Section 304 of the Securities and Futures Act, Chapter 289 of Singapore (the “SFA”) and “accredited investors” and other relevant persons in accordance with the conditions specified in Sections 305 of the SFA. In South Korea, information is issued by PGIM, Inc., which is licensed to provide discretionary investment management services directly to South Korean qualified institutional investors on a cross-border basis.    

Prudential Financial, Inc. of the United States is not affiliated in any manner with Prudential plc, incorporated in the United Kingdom or with Prudential Assurance Company, a subsidiary of M&G plc, incorporated in the United Kingdom. PGIM, the PGIM logo and Rock design are service marks of PFI and its related entities, registered in many jurisdictions worldwide.  The information on this website is not intended as investment advice and is not a recommendation about managing or investing your retirement savings. In making the information available on this website, PGIM, Inc. and its affiliates are not acting as your fiduciary.    

©2021 PFI and its related entities.