Beyond Public and Private

Why Risk Exposure and Liquidity Capacity Should Drive Asset Allocation

Institutional portfolios have traditionally been divided into two broad categories: public markets and private markets.
This distinction has shaped investment organisations, governance, benchmarks, reporting, and career paths. Public and private market teams are usually managed separately, and asset allocation often begins by determining capital allocation between these categories.
The distinction remains operationally important. Public and private investments differ in liquidity, valuation, governance, fees, manager dispersion, transparency, and implementation complexity.
However, from a total portfolio perspective, asset allocation should not begin with the distinction between public and private markets.
The more fundamental questions are:
Which economic risks and return sources should the institution own?
And:
Which implementation approach offers the most effective exposure, considering the institution’s liquidity capacity, tolerance, governance, and objectives?

Looking Beyond Asset-Class Labels

Many private assets share important economic characteristics with their public-market counterparts.
Private equity primarily provides exposure to corporate growth and residual enterprise value. Private credit offers exposure to contractual cash flows, default risk, and recovery outcomes. Infrastructure combines growth, inflation sensitivity, duration, regulatory risk, and operational exposure. Real estate reflects property income, financing conditions, inflation sensitivity, and economic growth.
This does not mean that public and private investments are economically identical.
Private market returns are also affected by leverage, complexity, control rights, company size, manager skill, valuation practices, origination capability, and illiquidity. These factors can significantly change an investment’s risk and return profile.
The key point is that “public” and “private” describe how assets are accessed and traded, but do not fully reflect the underlying economic risks.
Portfolios should therefore be built around underlying risk exposures, not only on asset-class labels.

Start with the Mandate and the Total Portfolio

Asset allocation should begin with the institution’s mandate.
Only after answering these questions should the institution determine which compensated risks to deliberately assume.
These may include:
The initial question should therefore not be:
“How much private equity should we own?”
It should be:
“How much growth exposure should the total portfolio own, and what is the most effective way to obtain it?”
Similarly, the question should not begin with:
“How much private credit should we allocate?”
It should begin with:
“How much credit risk should the institution own, in which parts of the capital structure, and through which implementation channels?”
From a Total Portfolio perspective, asset classes should not be treated as the fundamental economic building blocks. They are implementation structures through which institutions access combinations of risk premia.

Liquidity as a Portfolio Constraint and Strategic Resource

Once desired risk exposures are identified, liquidity becomes a central factor in allocation decisions.
Public markets typically provide continuous pricing and immediate access to capital. Private markets often require longer holding periods, uncertain cash flow timing, and limited exit opportunities near reported NAV (Net Asset Value).
This illiquidity may be associated with higher expected returns. Investors may be compensated for longer capital commitments, uncertain distributions, providing financing where capital is scarce, or accepting complexity that others avoid. The expected return differential may compensate investors not only for illiquidity, but also for complexity, leverage, information demands, origination requirements, governance burden and manager-selection risk.
However, an illiquidity premium is neither automatic nor constant.
Not all private assets offer adequate compensation for liquidity, leverage, fees, complexity, and manager risk. Capital inflows, competitive fundraising, and high entry valuations can reduce expected returns. Reported performance may also be influenced by valuation smoothing and delayed mark-to-market adjustments.
The relevant decision is therefore not simply whether an investment is illiquid.
The key question is whether the institution is adequately compensated, on a net and risk-adjusted basis, for all risks assumed.
Liquidity should be considered a scarce strategic resource. Allocating capital to illiquid investments limits the institution’s ability to rebalance, meet liabilities, fund capital calls, post collateral, and pursue future opportunities.

Liquidity Capacity, Tolerance and Appetite

It is important to distinguish among three related concepts.
These concepts should not be used interchangeably.
An institution may have significant liquidity capacity but limited governance tolerance. Another may have a long investment horizon but high collateral or cash-flow needs. A third may have both the capacity and conviction to hold more illiquid assets.
When liquidity capacity and tolerance are high, the institution may allocate more capital to investments that provide attractive compensation for illiquidity, complexity, or long-term commitment.
However, this decision should be based on expected compensation, not on the assumption that private assets consistently deliver superior returns.

Allocating Within Common Risk Exposures

A risk-factor-based approach reframes the comparison between public and private assets.
Instead of viewing public and private equity as separate allocation categories, the institution can assess them as alternative ways to gain growth exposure.
Similarly, rather than considering public bonds, syndicated loans, and private credit separately, the institution can evaluate how each contributes to credit, duration, default, and liquidity risk within the total portfolio. 
Adding private assets does not necessarily diversify the total portfolio if they replicate growth, credit, leverage, or other exposures already held elsewhere.
The allocation between implementation vehicles can then be guided by factors such as:

For a given risk exposure, institutions with higher liquidity capacity and appetite may allocate more capital to less liquid vehicles if the expected incremental return justifies it.
Institutions with lower liquidity capacity may prefer public or more liquid options, even if expected returns are lower, because liquidity adds value to the total portfolio.
The optimal allocation is not universal; it depends on how each implementation choice affects the institution’s total portfolio.

Public and Private Markets as Partly Substitutable Implementations

Public and private markets often serve as partly substitutable implementation channels.
Private equity is not a separate economic universe from equity. It is one way of obtaining corporate growth exposure, often combined with leverage, control, active ownership, concentration, and illiquidity.
Private credit is closely related to fixed income. It is one way to provide debt capital, often involving origination, structuring, covenant protection, borrower complexity, and limited liquidity.
However, public and private assets are not perfect substitutes.
Private markets may offer access to companies, projects, structures, and control rights not available in public markets. Public markets provide price discovery, transparency, scalability, lower costs, and more efficient rebalancing.
The Total Portfolio Approach does not ignore such distinctions. Instead, it evaluates them based on their contribution to the fund’s objectives, risks, and constraints.

Alternatives Are Becoming Less Alternative

The term “alternative investments” is less relevant now that private equity, private credit, infrastructure, and real estate are established components of institutional portfolios.
At the same time, the boundary between public and private markets has become more flexible.
Secondary markets have grown. Continuation vehicles provide new ways to extend or transfer ownership. Evergreen and semi-liquid structures offer investors more flexible commitment and redemption options.
These developments expand the range of implementation choices available to institutions. However, they do not eliminate illiquidity.
Secondary-market exits may require discounts, especially during stress. Evergreen structures may allow periodic redemptions, but underlying assets can remain illiquid. In some cases, liquidity risk is transferred to the fund structure or managed through redemption limits.
Therefore, contractual liquidity should not be confused with the actual economic liquidity of underlying assets.

The Asset-Allocation Decision

Under a Total Portfolio Approach, the allocation process should be reframed.
The institution first determines the economic risks it wishes to own. Next, it assesses how much liquidity, leverage, complexity, and manager dependence it can tolerate. Finally, it selects the mix of public and private implementation vehicles that provides the most attractive expected contribution to the total portfolio.
The central questions become:
These questions require more than market analysis. They require a clear understanding of the institution’s liabilities, cash-flow profile, governance, stakeholder behaviour, and investment horizon.
A defined-benefit pension plan with stable contributions and predictable benefit payments may have greater capacity for illiquid investments than an institution with uncertain withdrawals or significant collateral needs. However, a long-term investor is not always a long-horizon investor in practice. Governance, funding pressures, and stakeholder behaviour may limit the institution’s ability to remain invested.

Looking Ahead

The public-versus-private distinction will continue to matter for implementation, governance and risk management. However, it should not define the portfolio’s economic structure.
A Total Portfolio Approach begins with the institution’s mandate, identifies the risks and return sources required to meet it, and then determines the most effective combination of implementation vehicles. From this perspective, liquidity is not the only difference between public and private markets, but it is a key constraint when allocating capital among investments with similar risk exposures.
Institutions with higher liquidity capacity, tolerance, and appetite may own more illiquid assets when compensation is attractive. Those with greater liquidity needs may choose more liquid options, even at lower expected returns.
The objective is not to maximise private-market exposure; nor is it to preserve traditional asset-class boundaries.
It is to construct a total portfolio in which each investment is evaluated by its economic risks, liquidity consumption, and its role in fulfilling the institution’s mandate.
Institutions are not rewarded simply for owning asset classes. They are rewarded for bearing compensated risks that they are structurally and organisationally prepared to manage.
* Images generated using ChatGPT

Comments

Post a Comment

Popular posts from this blog

The Mandate Comes First

Image
One of the more enduring rewards of this year’s ALTSLA, once again, was the people. The quality of the conferences is usually assessed by the quality of their panels, the relevance of the themes, or the prominence of the speakers. All of that matters. But what stays with me most is usually the less formal part — the conversations between sessions, the chats over coffee, the passing comments that turn into more substantive discussions. For all the attention this industry gives to ideas, it is people who ultimately shape them. That was on my mind as I rode the train from Los Angeles to San Diego after the conference, enjoying the improbably warm weather compared with the East Coast. Over time, ALTSLA has become something of an annual ritual, and the two days of rest that follow it have become part of that rhythm as well — an opportunity to step away from the noise, reflect, and reset. Looking out at the ocean, I found myself returning to a question that strikes me as basic, but not basic...
Read more

Stockholm, Market Timing, and Broadening the Total Portfolio Conversation

Earlier this week, I visited Stockholm to participate in the Nordic Pension Tour. Thank you to Mirjam Guldemond, Sophie Baker, and Pensions & Investments for organizing an excellent program. It was one of those trips that reminds you why these conversations matter. Stockholm itself helped: the weather was beautiful, the city was full of that calm Scandinavian clarity, and even a short visit to the Nobel Prize Museum made it feel like a place where ideas still carry real weight. Before the World Pension Summit, I visited AP3, Alecta, and FTN. Each institution provided a unique perspective on how long-term asset owners think about their investment. At Alecta, I noted the central role of benchmarks. For liability-aware institutions, benchmarks are deeply embedded in the investment process. While this can be helpful, it raises an important question: when does a benchmark clarify the mandate, and when does it begin to replace it? At FTN, together with AP7, we discussed defined contribut...
Read more

Leadership Starts with Motivation

The older I get, the more I think leadership is less about authority and more about motivation. A leader’s job is not just to set direction, make decisions, or evaluate performance. Those things matter, of course. But if the people around you no longer feel motivated to contribute, improve, and stay, then a lot of the rest begins to break down. Motivation has never meant just compensation. Pay matters. Performance-based rewards matter. Fairness matters. But motivation also comes from something more basic: being treated with respect, being seen as an individual, and having a working relationship with your manager that feels human rather than mechanical. Every workplace is, in the end, a human system. People may stay for a while because of prestige, compensation, or obligation. But very few people do their best work for long in an environment where they feel invisible, unfairly treated, or repeatedly drained by the people around them. That is why I think good leadership requires more tha...
Read more