Im struggling with developing a framework on how to access the optimal allocation to illiquid stale priced asset in a multi asset/factor portfolio.
Fundamentally I have found evidence that the illiquidity premium for holding a given factor exposure in a illiquid form, like private equity, real estate, forestry does not compensate for the extended lock-up. Or in real option terminology the value of flexibility is higher, than the return spread illiquidity provide. Now assuming im correct, the only two argument for illiquid investments, is if they:
A. Provide access to exotic beta exposure, that is not available in liquid form and that may benefit the portfolio as a whole from a diversifying standpoint.
B. The stale pricing of such illiquid assets, may help to limit drawdowns on the portfolio.
I have earlier consulted with Glyn Holton from Riskchat.com on how we set the risk assessment on illiquid assets equal to liquid assets, so we can compare risk Apples-to-Apples ie. try to back out the autocorrelation, correct for lock-ups via a factor equal to SQRT (t), but Glyns perception is that we should not, as illiquid vs. liquid investments are fundamentally different.
I have thought of using the VaR concept in a ALM framework, using the first or fifth percentile of the funding surplus for illiquid investments, but how do you guys see it?
