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More About This Title Mastering Illiquidity - Risk Management forProfolios of Limited Partnership Funds
English
With 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
English
Dr PETER CORNELIUS is heading AlpInvest Partners’ economic and strategic research. Prior to his current position, he was the Group Chief Economist of Royal Dutch Shell, chief economist and Director of the World Economic Forum’s Global Competitiveness Program, Head of International Economic Research of Deutsche Bank, a senior economist with the International Monetary Fund, and a staff economist of the German Council of Economic Advisors. He is the chairman of EVCA’s ‘Risk Measurement Guidelines’ working group. He has been an adjunct professor at Brandeis University and a Visiting Scholar at Harvard University and has published widely in leading academic and trade journals and (co)authored several books, including International Investments in Private Equity (Elsevier/Academic Press).
Dr CHRISTIAN DILLER is co-founder of Montana Capital Partners, focused on secondary liquidity in private equity through its own innovative investment product, sophisticated securitizations and risk management services for institutional investors. Previously, he was Head of Solutions at Capital Dynamics leading the structuring and portfolio and risk management activities. Christian advised some of the world’s largest investors on portfolio rebalancing and structuring, cash flow planning and risk management in private equity. Prior to that, he worked for Allianz Group and Pioneer Investments. Christian is a member of the EVCA’s ‘Risk Measurement Guidelines’ working group, co-chairman of the ‘Technical Working Group on Solvency II & IORP’ and lecturer at the CIPEI course held by the Oxford Said Business School. He is author of several articles for practitioners and academics and holds a Dr. rer. pol. in finance specializing on risk-/return characteristics of private equity funds.
Dr DIDIER GUENNOC is co-founder of LDS Partners, specialised in decision systems, program structuring, corporate governance and risk management solutions for institutional investors in private equity. He also acts as the secretary of the International Private Equity and Venture Capital Valuation Board (IPEV Board). Previously he worked for Origo Management and advised EVCA, the European Private Equity and Venture Capital Association on public affairs, statistics and professional standards. He started his career at Xerfi, the leading French market research company. Didier was a member of the advisory board of the Centre for Entrepreneurial and Financial Studies (Technische Universität München – Germany) and of the private equity subcommittee of the Chartered Alternative Investment Analyst® Program. Didier holds a PhD in Business Administration from the University Robert Schuman, Strasbourg (France).
Dr THOMAS MEYER is co-founder of LDS Partners, specialised in decision systems, program structuring, corporate governance and risk management solutions for institutional investors in private equity. Previously he was with EVCA, the European Investment Fund and Allianz Asia Pacific. He is a member of the EVCA’s ‘Risk Measurement Guidelines’ working group and of the Chartered Alternative Investment Analyst Association's (CAIA©) private equity sub-committee and a Shimomura Fellow of the Development Bank of Japan’s Research Institute of Capital Formation. Thomas is co-directing the Certificate in Institutional Private Equity Investing (CIPEI) course held by the Oxford Said Business School’s Private Equity Institute and co-authored several books including Beyond the J-Curve and J-Curve Exposure.
English
Foreword xi
Acknowledgements xiv
1 Introduction 1
1.1 Alternative investing and the need to upgrade risk management systems 1
1.2 Scope of the book 4
1.3 Organization of the book 6
PART I ILLIQUID INVESTMENTS AS AN ASSET CLASS
2 Illiquid Assets, Market Size and the Investor Base 17
2.1 Defining illiquid assets 17
2.2 Market size 20
2.3 The investor base 23
2.4 Conclusions 32
3 Prudent Investing and Alternative Assets 33
3.1 Historical background 34
3.2 Prudent investor rule 36
3.3 The OECD guidelines on pension fund asset management 38
3.4 Prudence and uncertainty 38
3.5 Conclusion 41
4 Investing in Illiquid Assets through Limited Partnership Funds 43
4.1 Limited partnership funds 43
4.2 Limited partnerships as structures to address uncertainty and ensure control 47
4.3 The limited partnership fund’s illiquidity 49
4.4 Criticisms of the limited partnership structure 52
4.5 Competing approaches to investing in private equity and real assets 52
4.6 A time-proven structure 55
4.7 Conclusion 57
5 Returns, Risk Premiums and Risk Factor Allocation 59
5.1 Returns and risk in private equity 59
5.2 Conclusions 73
6 The Secondary Market 75
6.1 The structure of the secondary market 76
6.2 Market size 83
6.3 Price formation and returns 87
6.4 Conclusions 93
PART II RISK MEASUREMENT AND MODELLING
7 Illiquid Assets and Risk 97
7.1 Risk, uncertainty and their relationship with returns 98
7.2 Risk management, due diligence and monitoring 102
7.3 Conclusions 105
8 Limited Partnership Fund Exposure to Financial Risks 107
8.1 Exposure and risk components 108
8.2 Funding test 113
8.3 Cross-border transactions and foreign exchange risk 117
8.4 Conclusions 121
9 Value-at-Risk 123
9.1 Definition 123
9.2 Value-at-risk based on NAV time series 124
9.3 Cash flow volatility-based value-at-risk 129
9.4 Diversification 136
9.5 Factoring in opportunity costs 141
9.6 Cash-flow-at-risk 143
9.7 Conclusions 144
10 The Impact of Undrawn Commitments 149
10.1 Do overcommitments represent leverage? 150
10.2 How should undrawn commitments be valued? 151
10.3 A possible way forward 153
10.4 Conclusions 159
11 Cash Flow Modelling 161
11.1 Projections and forecasts 162
11.2 What is a model? 163
11.3 Non-probabilistic models 167
11.4 Probabilistic models 171
11.5 Scenarios 178
11.6 Blending of projections generated by various models 179
11.7 Stress testing 180
11.8 Back-testing 184
11.9 Conclusions 187
12 DistributionWaterfall 189
12.1 Importance as incentive 190
12.2 Fund hurdles 191
12.3 Basic waterfall structure 193
12.4 Examples for carried interest calculation 195
12.5 Conclusions 202
13 Modelling Qualitative Data 207
13.1 Quantitative vs. qualitative approaches 207
13.2 Fund rating/grading 208
13.3 Approaches to fund ratings 211
13.4 Use of rating/grading as input for models 216
13.5 Assessing the degree of similarity with comparable funds 218
13.6 Conclusions 220
14 Translating Fund Grades into Quantification 221
14.1 Expected performance grades 221
14.2 Linking grades with quantifications 225
14.3 Operational status grades 228
14.4 Conclusions 229
PART III RISK MANAGEMENT AND ITS GOVERNANCE
15 Securitization 233
15.1 Definition of securitization 233
15.2 Financial structure 237
15.3 Risk modelling and rating of senior notes 239
15.4 Transformation of non-tradable risk factors into tradable financial securities 244
15.5 Conclusions 248
16 Role of the Risk Manager 249
16.1 Setting the risk management agenda 249
16.2 Risk management as part of a firm’s corporate governance 251
16.3 Built-in tensions 253
16.4 Conclusions 255
17 Risk Management Policy 257
17.1 Rules or principles? 258
17.2 Risk management policy context 258
17.3 Developing a risk management policy 262
17.4 Conclusions 264
References 267
Abbreviations 277
Index 279
