Optimal Pacing for Private Assets: An Example

The FRG Private Capital Forecasting (PCF) solution recently released a module for optimal pacing.  Pacing refers to the planning of future commitments. Future commitments encompass a decision on commitment size as well as a decision on commitment timing. This is done to help balance a portfolio’s needs to achieve or maintain allocations to private capital vehicles.

Creation of pacing plans is not straightforward. The plan should consider not just the allocations to private asset classes, but to other asset classes as well. It also needs to balance these commitments with liquidity constraints and the need to keep all asset classes from breaching risk limits.

The Pacing Module combines the class-leading PCF forecasting simulation with stated portfolio goals for allocation and limits with a non-linear optimizer to create optimal pacing plans.

This blog posts walks through an example pension fund that is in a net distribution scenario.  They are actively selling down the portfolio to fund retirements. Further, they have only recently begun to invest in private capital. Their allocations are low and need to be brought up to target.

PCF has been configured with this information. The fund manager has specified semi-annual rebalancing for the public side of the portfolio.

The simulation will run through 2027 and the plan will be created for vintage years 2020 – 2024.  Investments will be planned in the sub-asset classes of Private Equity (Buyout and Fund of Funds), Real Estate, and Venture.

The fund is experiencing outflows.  Overall NAV of the portfolio is declining.

Charts showing allocation and NAV

 

The first graph shows the expected cash needs per quarter to fund employee retirements.  This represents cash leaving the portfolio and leading to a decline in total NAV.

The second chart shows the NAV growing out of the pandemic recession and then beginning to decline as cash requirements outstrip fund growth.  The mean and inner quartile range from the simulation are plotted.

Because NAV of the portfolio is declining pacing is extremely challenging. Investing too much risks an illiquid portfolio, unable to be sold to meet retiree needs.  Investing too little might mean that the portfolio does not reach its allocation target and undershoots the expected return.  The portfolio manager is in a bind.

Graphs shows portfolio allocation total before PCF optimization

The fund is underweight to private assets.  The manager needs to build the portfolio allocation to meet the expected return target, but as stated above, investing too much could cause liquidity problems down the road.

The Pacing module takes the simulation of the portfolio and optimally chooses which and how much vintages to invest in.  Once the optimization has been run, we can see the allocations through time are better in line with the targets:

Chart showing improved allocations after optimization has been run.

 

If you would like more information about VOR Private Capital Forecasting or the VOR Pacing Optimization Module, please download our white papers here or reach out to Dominic Pazzula.

Dominic Pazzula is FRG’s Director of Risk and Asset Allocation. He is a specialist in investment management, asset allocation, portfolio construction, and risk management.