Nick Dignam from Fortitude Investment Partners shares insights with Lachlan Maddock from Fortitude Investment Partners on how a diversified portfolio in mid-market private equity is structured. The Inside Adviser
The world of alternative investments is at a crossroads. As markets defy expectations and liquidity concerns take centre stage, investors find themselves forced to rethink how they deploy capital in an increasingly complex environment.
The three distinct buckets of alternative investments liquidity management
Alternative investments play a vital role in asset management, serving multiple functions within a portfolio including the provision of capital growth, income, risk diversification and downside protection.
Before incorporating an alternative investment into a client’s portfolio, however, it is crucial to understand its role and how it affects the overall risk profile and investment goals.
A common challenge in assessing alternatives is the tendency to overestimate their diversification benefits due to illiquidity and “volatility smoothing” from infrequent pricing. To gain a clearer picture of their risk impact, advisers and consultants should focus on identifying the primary risk drivers of each alternative investment.
At Atchison, we categorise alternative investments into three distinct buckets – liquid, semi-liquid, and illiquid – before determining their role within a portfolio. This framework is essential for effective implementation and risk management, as each category requires a tailored approach to integration.
The first and most accessible category is liquid alternatives, which are often the most suitable for a broad client base. Liquid alternatives are defined by investments with at minimum daily liquidity. These investments can be seamlessly incorporated into client SMAs, allowing for ease of implementation and flexibility.
The current market offers a wide range of listed alternatives, from growth-oriented assets like listed private equity to defensive options such as gold ETFs. However, Atchison notes that the liquid alternatives landscape is generally skewed towards defensive assets, which may limit their effectiveness in achieving certain client objectives.
Atchison defines semi-liquid alternatives as investments with liquidity terms ranging from monthly to quarterly or semi-annual redemption windows. While these assets do not fit within a standard SMA structure, they can be held on-platform as a side pocket allocation, providing investors with access to a broader range of alternative opportunities.
Semi-liquid alternatives often offer a balance between liquidity and the return potential of illiquid investments, making them a valuable tool for portfolio diversification. However, their less frequent liquidity, compared to liquid alternatives, means careful planning is required to align them with client needs, ensuring they complement the overall portfolio structure without creating unexpected liquidity constraints.
Finally, illiquid alternatives require the highest level of expertise and are best suited for professional management due to their complexity. These investments present two key challenges that must be carefully navigated. The first challenge is the high capital requirements and operational scale needed to invest effectively. Illiquid alternatives often require substantial upfront commitments, making them more suitable for larger, high-net-worth investors who can accommodate the long investment horizons and capital constraints.
The second challenge is detailed liquidity planning, which goes beyond managing investor cash flows – it also involves maintaining the intended alternatives exposure within a portfolio. Investors must understand the nuances of capital calls, particularly in asset classes like unlisted private equity. Unlike traditional investments, where capital is deployed immediately, private equity funds require investors to commit capital upfront, but the timing and amount of actual capital calls remain uncertain. As a result, an investor may have committed funds but not yet achieved their intended level of exposure.
Atchison addresses this complexity by constructing a multi-year liquidity planning model, ensuring investors maintain their desired allocation to alternatives over time. For example, as one investment is called, another commitment can be made so that when an existing investment rolls off, a new one is ready to be deployed. This structured approach helps investors optimise their alternatives exposure while minimising cash drag and liquidity mismatches.
By categorising alternatives based on liquidity, Atchison provides investors with greater clarity on risks and return expectations in a market that often lacks transparency. This approach also helps identify the most effective implementation strategies, ensuring alternative investments align with client objectives and portfolio construction goals.
