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Arms investors with powerful new tools for measuring and managing the risks associated with the various illiquid asset classesWith risk-free interest rates and risk premiums at record lows, many investors are turning to illiquid assets, such as real estate, private equity, infrastructure and timber, in search of superior returns and greater portfolio diversity. But as many analysts, investors and wealth managers are discovering, such investments bring with them a unique set of risks that cannot be measured by standard asset allocation models. Written by a dream team of globally renowned experts in the field, this book provides a clear, accessible overview of illiquid fund investments, focusing on what the main risks of these asset classes are and how to measure those risks in today's regulatory environment.* Provides solutions for institutional investors in need of guidance in today's regulatory environment* Offers detailed descriptions of risk measurement in illiquid asset classes, illustrated with real life case studies* Helps you to develop reliable risk management tools while complying with the regulations designed to contain the individual and systemic risks arising from illiquid investments* Features real-life case studies that capture an array of risk management scenarios you are likely to encounter

Mastering Illiquidity: Risk management for portfolios of limited partnership funds

Foreword xiAcknowledgements xiv1 Introduction 11.1 Alternative investing and the need to upgrade risk management systems 11.2 Scope of the book 41.3 Organization of the book 6PART I ILLIQUID INVESTMENTS AS AN ASSET CLASS2 Illiquid Assets, Market Size and the Investor Base 172.1 Defining illiquid assets 172.2 Market size 202.3 The investor base 232.4 Conclusions 323 Prudent Investing and Alternative Assets 333.1 Historical background 343.2 Prudent investor rule 363.3 The OECD guidelines on pension fund asset management 383.4 Prudence and uncertainty 383.5 Conclusion 414 Investing in Illiquid Assets through Limited Partnership Funds 434.1 Limited partnership funds 434.2 Limited partnerships as structures to address uncertainty and ensure control 474.3 The limited partnership fund's illiquidity 494.4 Criticisms of the limited partnership structure 524.5 Competing approaches to investing in private equity and real assets 524.6 A time-proven structure 554.7 Conclusion 575 Returns, Risk Premiums and Risk Factor Allocation 595.1 Returns and risk in private equity 595.2 Conclusions 736 The Secondary Market 756.1 The structure of the secondary market 766.2 Market size 836.3 Price formation and returns 876.4 Conclusions 93PART II RISK MEASUREMENT AND MODELLING7 Illiquid Assets and Risk 977.1 Risk, uncertainty and their relationship with returns 987.2 Risk management, due diligence and monitoring 1027.3 Conclusions 1058 Limited Partnership Fund Exposure to Financial Risks 1078.1 Exposure and risk components 1088.2 Funding test 1138.3 Cross-border transactions and foreign exchange risk 1178.4 Conclusions 1219 Value-at-Risk 1239.1 Definition 1239.2 Value-at-risk based on NAV time series 1249.3 Cash flow volatility-based value-at-risk 1299.4 Diversification 1369.5 Factoring in opportunity costs 1419.6 Cash-flow-at-risk 1439.7 Conclusions 14410 The Impact of Undrawn Commitments 14910.1 Do overcommitments represent leverage? 15010.2 How should undrawn commitments be valued? 15110.3 A possible way forward 15310.4 Conclusions 15911 Cash Flow Modelling 16111.1 Projections and forecasts 16211.2 What is a model? 16311.3 Non-probabilistic models 16711.4 Probabilistic models 17111.5 Scenarios 17811.6 Blending of projections generated by various models 17911.7 Stress testing 18011.8 Back-testing 18411.9 Conclusions 18712 DistributionWaterfall 18912.1 Importance as incentive 19012.2 Fund hurdles 19112.3 Basic waterfall structure 19312.4 Examples for carried interest calculation 19512.5 Conclusions 20213 Modelling Qualitative Data 20713.1 Quantitative vs. qualitative approaches 20713.2 Fund rating/grading 20813.3 Approaches to fund ratings 21113.4 Use of rating/grading as input for models 21613.5 Assessing the degree of similarity with comparable funds 21813.6 Conclusions 22014 Translating Fund Grades into Quantification 22114.1 Expected performance grades 22114.2 Linking grades with quantifications 22514.3 Operational status grades 22814.4 Conclusions 229PART III RISK MANAGEMENT AND ITS GOVERNANCE15 Securitization 23315.1 Definition of securitization 23315.2 Financial structure 23715.3 Risk modelling and rating of senior notes 23915.4 Transformation of non-tradable risk factors into tradable financial securities 24415.5 Conclusions 24816 Role of the Risk Manager 24916.1 Setting the risk management agenda 24916.2 Risk management as part of a firm's corporate governance 25116.3 Built-in tensions 25316.4 Conclusions 25517 Risk Management Policy 25717.1 Rules or principles? 25817.2 Risk management policy context 25817.3 Developing a risk management policy 26217.4 Conclusions 264References 267Abbreviations 277Index 279