Likewise, I have pondered what the return premium encompasses (encompassed?). If it were a pure illiquidity premium, it would be more or less persistent barring shocks and lags in pricing. As this article alludes to, it is a catch-all that includes financial engineering, leverage, capacity for dividend recaps, some operational improvement/expertise, etc, etc, etc. Not all are persistent either, as we are learning.
Thanks Henry. People often misunderstand the illiquidity premium. Especially Alts-sellers; I think it was Upton Sinclair who said that it's hard to get someone to understand something when thier salary depends on them not understanding it.
Historically, some types of assets that are illiquid have been associated with (on average) higher returns. Also it is intuitive and logical that if you lock up your money, you should expect a higher return. I guess this is where the liquidity premium got its start. Now, in the wealth channel (I listen to a lot of podcasts :) it feels like the magic words that get people's checkbooks out.
However, that there is a historical association (between illiquidity and higher returns) does not mean there is a direct connection between the two. There have been plenty of PE funds that have bombed (and in any case I'd argue that the illiquidity premium has been much smaller than thought for PE).
Any capital markets assumptions that derive PE returns by saying:
...and simply plugging the historical figure for the iliquidy premium) Is getting it fundamentally wrong. As they Italians say "Magari"-- if only it were true, but its not. I've seen CMAs that do this.
You could argue that for clarity's sake it should be fully divorced from the other factors (leverage, etc) and should be thought of as what investors demand in return for not being able to get at thier cash. Some Hedge Funds have (or should have) an illiquidity premium too.
Agree with the approach of mapping PE returns vs a credible benchmark. Also agree with understanding the return drivers of PE. One potential addition is understanding the return drivers of the credible benchmarks. Margin and multiple expansion have added 100's of bps to annual S&P returns since the GFC. The secular shift to passive likely contributed to multiple expansion. Low interest rates, lower taxes, arbing global labor costs, and the rise of tech aided margins. AQR assumes no reversion in their CMAs. If these do revert public equity returns will have stuff headwinds.
Who would've guessed that the battle at the top is a bunch of sales people
Likewise, I have pondered what the return premium encompasses (encompassed?). If it were a pure illiquidity premium, it would be more or less persistent barring shocks and lags in pricing. As this article alludes to, it is a catch-all that includes financial engineering, leverage, capacity for dividend recaps, some operational improvement/expertise, etc, etc, etc. Not all are persistent either, as we are learning.
Thanks Henry. People often misunderstand the illiquidity premium. Especially Alts-sellers; I think it was Upton Sinclair who said that it's hard to get someone to understand something when thier salary depends on them not understanding it.
Historically, some types of assets that are illiquid have been associated with (on average) higher returns. Also it is intuitive and logical that if you lock up your money, you should expect a higher return. I guess this is where the liquidity premium got its start. Now, in the wealth channel (I listen to a lot of podcasts :) it feels like the magic words that get people's checkbooks out.
However, that there is a historical association (between illiquidity and higher returns) does not mean there is a direct connection between the two. There have been plenty of PE funds that have bombed (and in any case I'd argue that the illiquidity premium has been much smaller than thought for PE).
Any capital markets assumptions that derive PE returns by saying:
Public equity expected returns + illiquidity premium = expected private equity return
...and simply plugging the historical figure for the iliquidy premium) Is getting it fundamentally wrong. As they Italians say "Magari"-- if only it were true, but its not. I've seen CMAs that do this.
You could argue that for clarity's sake it should be fully divorced from the other factors (leverage, etc) and should be thought of as what investors demand in return for not being able to get at thier cash. Some Hedge Funds have (or should have) an illiquidity premium too.
Agree with the approach of mapping PE returns vs a credible benchmark. Also agree with understanding the return drivers of PE. One potential addition is understanding the return drivers of the credible benchmarks. Margin and multiple expansion have added 100's of bps to annual S&P returns since the GFC. The secular shift to passive likely contributed to multiple expansion. Low interest rates, lower taxes, arbing global labor costs, and the rise of tech aided margins. AQR assumes no reversion in their CMAs. If these do revert public equity returns will have stuff headwinds.
Brett, thanks for the comment and very good points.