Cash for Calls: Managing Liquidity for Illiquid Investments

Many investors seeking higher returns have turned to private assets. Vehicles focusing on private equity, real estate, and private credit generally offer an illiquidity premium. But they also present a liquidity-management challenge: Investors must maintain a ready pool of funds to meet capital calls, which can occur at any time.

When measuring return on committed capital, holding cash may be suboptimal and erode the Illiquidity premium investors seek. So how can one optimize the risk and return of uncalled capital?

We propose a framework based on historical call behavior of private equity and private debt funds. We detailed our analysis last month in the In Depth piece, “Cash for Calls: A Quantitative Approach to Managing Liquidity for Capital Calls.” A tiered approach to liquidity, in which holdings correspond to risk and timing considerations, lies at its core.

Figure 1: Holding cash can erode total returnsImage Pop Up

Traditional approaches

There are two broad approaches to managing uncalled capital.

Conservative investors tend to set aside a portion of their commitment in cash or Treasuries. However, this approach may lead to substantial cash drag on the overall expected returns of the illiquid strategy. By some measures, the drag could amount to almost a third of the 15% net internal rate of return (IRR) often targeted by private equity funds (see Figure 1).