Valuing a Lost Opportunity

An Alternative Perspective on the Illiquidity Discount

By Jamil Baz, Christian Stracke, Steve Sapra

  • 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.

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