Managing Illiquidity in Open‑Ended Funds with Private Asset Allocations

Challenges and Solutions

Abstract

This paper explores the potential benefits and challenges of allocating to private assets in open‑ended funds. While private equity and private debt can enhance diversification and returns through an illiquidity premium, their long lock‑ups, capital calls and distributions, and valuation practices complicate their integration into liquid investment vehicles. We provide empirical evidence of an illiquidity premium for private equity and private debt using benchmark indices and discuss the impact of valuation lag and smoothing on portfolio risk and performance. We then present a dynamic recommitment strategy to illustrate how open‑ended funds can maintain stable target allocations to private assets and more effectively capture fund‑level internal rate of returns by avoid return dilution from cash drag, while relying on public equity and debt allocations to provide liquidity and manage cash flows. Using a stylized portfolio allocation, we conduct stress tests to analyze drift in portfolio weights during market crises and under significant investor redemptions. Finally, we address the launch of open‑ended funds by proposing ramp‑up strategies that accelerate convergence toward target private asset allocations while limiting the risk of overshooting. Overall, the paper provides a practical framework for constructing open‑ended portfolios with private assets, expanding access to this asset class for a broader investor base.