In the wake of the Global Financial Crisis, institutional investors were rightfully concerned about the liquidity profiles of their long term portfolios. Although markets have recovered substantially since the depths of that crisis, illiquidity remains an important topic with lingering concerns about locking up capital for 10-plus years.
At Commonfund we believe there are compelling reasons to maintain allocations to illiquid strategies, not the least of which is the potential to earn excess return over liquid or public investments. The potential for achieving an illiquidity premium, however, is not the the topic of this post. Instead we challenge the perception that private investments are locked up for 10-plus years and conclude through our analysis that these investments are in fact not as illiquid as many fear.
First, we considered the actual time that dollars are invested and thus illiquid. For this analysis we focused on private equity, an investment strategy generally structured as 10-to-12 year partnerships and used data from one of our own private equity programs that is nearly fully realized. While investors commit capital for the duration of the legal structure of the partnership, the reality is that their dollars were only invested for less than half of the life of the partnership because of the dynamic of dollars being called for investment over time and not all at once and then returned to investors in the form of distributions. In the private equity program we evaluated, there were 423 fully realized investments meaning they were sold and proceeds distributed to investors. The average time between initial investment and final exit date was 4.5 years. In fact when we analyzed more than 9,000 realized investments across all private capital programs in Commonfund Capital's history we discovered that the average holding period was 5.2 years leading us to conclude that investors do not lock-up their capital for 10-12 year but rather for half of that time.
We also considered two other methodologies for determining the degree of illiquidity in private equity that included analyzing the dollar-weighted average time between capital being invested and capital being distributed as well as the average time it would take for an invested dollar to achieve a target return. In both cases we found the number of years to be less than five supporting the conclusion that private capital is not as illiquid as many perceive.
Lastly we have observed that since we conducted the research for the original article over two years ago the secondary market has continued to grow and mature and today provides a viable exit avenue for owners of private investments. In a secondary transaction, a buyer purchases an existing interest in a partnership at an agreed upon price and takes over the existing investment and/or commitment thereby providing and exit and liquidity to the seller.
We continue to believe that illiquid investments are an important component of a long term investment portfolio and would encourage investors to consider their illiquidity budgets and liquidity needs with a full understanding of the characteristics of their illiquid investments.
For more information describing our methodology, additional statistics and in-depth findings, read the full article.