Evaluating the impacts of illiquidity on portfolios allocating to private assets
Fidelity Institutional Wealth Adviser (FIWA) has developed a proprietary, research-driven liquidity analysis framework to help advisors and their clients to consider when implementing alternative investments.
- FIWA has developed a proprietary liquidity analysis framework and target asset mixes based on risk tolerance and liquidity needs for advisors and their clients to consider when implementing alternative investments.
- The spending shortfall analysis seeks to quantify the risks of illiquidity at various asset levels and rates of spending as a percentage of financial assets during significant market drawdowns or life events. The allocation drift analysis assesses the likelihood that annual withdrawals, along with the impact of illiquidity, could result in a material deviation from target allocations over time.
- The framework, combined with FIWA’s portfolio construction methodology, concludes that up to 30% in private assets may be appropriate for individuals with greater than $5 million in household financial assets, and up to 15% for those with $1 million to $5 million. Allocations to private assets may not be appropriate for households with less than $1 million in assets, based on spending rates.
- Depending on the target asset mix and percent allocated to private assets, higher annual withdrawal rates may increase the risk of deviating from target allocations. However, the impacts may be mitigated in target asset mixes with higher allocations to income-producing asset classes such as private debt and private real estate.
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Alternative investments are investment products other than the traditional investments of stocks, bond, mutual funds, or ETFs. Examples of alternative investments are limited partnerships, limited liability companies, hedge funds, private equity, private debt, commodities, re al estate, and promissory notes. Some of the risks associated with alternative investments are: Alternative investments maybe relatively illiquid. It may be difficult to determine the current market value of the asset. There may be limited historical risk and return data. A high degree of investment analysis maybe required before buying. Costs of purchase and sale may be relatively high.