What this module covers
An allocation framework is the set of rules used to decide how much capital goes into private markets and how that capital is spread once it is there. This module describes how such frameworks are built. The size of an allocation is what a framework produces when it is applied to one investor's circumstances.
- Why private holdings need a framework at all
- The factors frameworks weigh
- The liquidity principle
- Diversification across asset classes
- The barbell, one framework described in detail
- Diversification across vintage years and managers
- Limits on total illiquid holdings
Why private holdings need a framework
A listed portfolio that drifts away from its targets can be adjusted in a day. A private holding cannot. A commitment to a private fund is drawn down over a period of years. Capital comes back on the manager's schedule, not the investor's. An interest usually cannot be sold before the fund ends except on the secondary market, often at a discount to its reported value, and sometimes there is no buyer at all.
Decisions about size and spread are therefore made in advance, and they are hard to reverse. A framework is how that advance decision is made deliberately, rather than one investment at a time as each one is presented. Module 17 describes the reactive alternative, investing without a written plan, as one of the recurring mistakes in private markets.
What institutions do, and why their numbers do not transfer
Canada's large pension plans publish what they hold, and module 02 describes those allocations and the reasons the plans give for them. This module uses the plans for their method.
A pension plan sizes its illiquid holdings against its own horizon and its own liquidity needs. Both are unusual. Its obligations run for decades, and it plans for the cash it will need to pay them. An individual investor's horizon is shorter, and the calls on an individual's cash are harder to predict. Frameworks for individuals therefore borrow the institutional method, which is to size illiquid holdings against horizon and liquidity. They do not borrow the institutional result.