Investor Insights

How Does the Illiquidity of Private Markets Affect Asset Allocation?

It helps to view liquidity through the lens of return and risk

July 2020

Our research on “Liquidity and Portfolio Choice” provides a framework for asset owners to evaluate the benefits of liquidity and costs of illiquidity, and implications for strategic asset allocation.

Investors intuitively understand that the ability to trade confers some additional benefit and that the inability to trade has a cost. Even a small amount of illiquidity could create an opportunity cost for the portfolio.

Our liquidity framework reflects the value of liquidity by attaching shadow assets to tradable assets and shadow liabilities to non-tradable assets. In doing so, we measure these benefits and costs explicitly in units of portfolio return and risk, which can be incorporated into standard portfolio construction algorithms such as mean-variance analysis.