- As private strategies play a more prominent role in investors’ portfolios, many asset allocators are interested in what illiquidity discount they should command as compensation for tying up capital.
- When investors commit capital to a fund with lockups, they effectively give up the opportunity to take advantage of future opportunities.
- We take an alternative approach to assessing the illiquidity discount by modeling this opportunity cost.
- The “optimal” illiquidity discount will compensate the investor for this opportunity cost.
- The illiquidity discount investors should command will reflect their perceived skill and alpha-generating abilities.
- We find illiquidity discounts on the order of 1.5%–2% per year are reasonable for most investors, but they are much higher for investors who are highly skilled.