Reducing the inherent risk of private capital 

How we’re democratizing forecasting for illiquid alternatives

Private market assets now comprise 25 percent of institutional portfolios, contributing to nearly half of overall returns. As this asset class continues to grow, its inherent risks can no longer be overlooked. Dr. Thomas Meyer has studied illiquid assets for nearly 25 years and his pioneering cash flow forecasting models emerge as a solution to this pressing challenge. In his work with SimCorp, he’s moved beyond theory to incorporate these capabilities into our integrated platform SimCorp One, so that our clients can now easily manage private assets on equal footing as public market instruments. 

In his recent book, The Art of Commitment Pacing, Dr. Meyer lays out the foundational pieces to commitment pacing and risk management, including rigorous forecasting. He offers the perfect mix of theoretical and practical insights: 

1. How can I measure & control real exposure to private assets? 
2. How do I forecast cash flows for commitments to private capital funds? 
3. What are realistic ranges for returns and lifetime?  
4. Which dimensions should I consider for a well-diversified portfolio? How much diversification is enough? 
5. How can I model the impact of co-investments and secondaries? 

Cash flow and exposure forecasts become a daily expectation

Thanks to Dr. Meyer’s work, SimCorp One provides a sophisticated solution that can run cash flow forecasting daily. This is in stark contrast to current practices where most asset managers are usually provided with forecasts once a year. This helps Limited Partners (LPs) optimize portfolios with allocation to liquid and illiquid assets alike and find the Goldilocks zone for cash exposures.  

Ultimately, better estimates of the probabilities of future cash flows provide improved cash management capabilities to prevent illiquidity risks and performance drag due to excess idle cash. 

To effectively manage the growing allocation to alternative investments, investment managers need a more robust risk framework that entails: 

1. Embracing a total portfolio approach 
2. Simplifying cash flow forecasting 
3. Advancing cash flow forecasting models 

Harnessing total portfolio for better decision making

Investing in private markets brings inherent uncertainties to the LPs stemming from long investment horizons, poor data availability, lack of liquid secondary markets, and a lack of standardization. These nuances render private assets impossible to properly manage within a conventional risk management framework. 

With advances in data, technology, and analytics, it is possible to treat private assets’ risks on equal footing to those of liquid asset classes. With a true multi-asset, end-to-end operating platform comprising portfolio, risk, and data management, LPs can construct their portfolios in an innovative way that has the potential to generate higher risk-adjusted returns.  

This would entail a Total Portfolio Approach (TPA) where the full capital is used to maximize the net impact of investments by diversifying over various risk factors across all asset classes, enabling greater diversification in the hunt for better returns. 

From a total plan risk point of view, you must have a common set of market risk factors that align private assets with public market assets. However, that’s not enough. To fully implement the TPA, you must be able to address the unique aspects of private market investments, including irregular cash flow requirements leading to funding risk, and additional dimensions like illiquidity risk and capital risk. 

Simplifying cash flow forecasting in private markets 

One of the most important aspects of investing in private market versus public markets is the uncertainty of cash flow for LPs—be it the timing of capital calls or the timing of distributions. Given that there is no efficient secondary market to offload assets and raise cash, cash flow forecasting has become of paramount importance. Hold too little cash and the LPs renege on their private asset commitments, hold too much cash and it becomes a performance drag. 

The key enabler to the TPA is a highly automated cash flow forecasting tool to overcome this major roadblock: the difficulty of reliably projecting exposure changes and liquidity streams for their illiquid asset portfolios. Historically, most LPs find it so difficult to forecast that they typically do it only once a year and thus are forced to approach allocations to illiquid assets ultra-cautiously or risk running into funding risk. 

What are the complexities of producing cash flow forecasts more frequently? The scarcity of data, the complexity of modeling to make use of this data, and having the expert who can put it all together. These are important considerations that Dr. Meyer built into the cash flow forecasting capability in SimCorp One.  



Advancing cash flow forecasting models  

The LPs managing private asset have historically relied on purely deterministic models like the Takahashi-Alexandar Model to estimate future cash flow requirements. The challenge of those models is that they solely rely on historical data. This limits their explanatory power as LPs would be relying on a limited set of historical data and a lot of judgment is needed to implement correctly. 

That’s what Dr. Meyer and his team sought to improve upon when they embarked on the approach that is being done in his work at SimCorp—to address the limitations of a model derived from fixed parameters which may be too simplistic or irrelevant. To better incorporate the variability of data observed in such complex scenarios, he has built stochastic models that explicitly account for uncertainty and randomness, leveraging a rich set of private market data to set the parameters that determine the dynamics of such models. 

In addition to the realism and robustness that stochastic models solve for systems that are inherently uncertain, it also allows modelling flexibility in situations where specific fund data doesn’t exist, for example, or when the strategy is new, or available data represents too small of a sample size for statistical significance. In this case, LPs can interpret comparable strategies, adjust parameters based on their assessment of the situation, and later refine these settings when more data becomes available. 

Dr. Meyer’s work forms the foundation of SimCorp One’s forecasting models for illiquid alternative investments. Explore his insights in his new book: “The Art of Commitment Pacing”

About Dr. Meyer

Dr. Thomas Meyer is a Senior Product Manager at SimCorp Luxembourg s.a.r.l. (part of Deutsche Börse Group). He has held an international career in and out of the financial services, from intelligence officer in the German Air Force to regional CFO of Allianz Asia Pacific in Singapore. He was responsible for the creation of the European Investment Fund’s risk-management function with focus on building valuation and risk-management models and investment strategies for venture capital funds of funds. Since 2020, he has been leading the development of SimCorp’s Alternatives Strategy solution. 

Dr. Meyer is a Shimomura Fellow of the Development Bank of Japan and was a visiting research fellow at Hitotsubashi University in Tokyo. He just published his new book ‘The Art of Commitment Pacing’ (by Wiley). He is the co-author of Beyond the J Curve (translated into Chinese, Japanese, and Vietnamese), J-Curve Exposure, Mastering Illiquidity (all by Wiley), and two CAIA books, which are required reading for Level II of the Chartered Alternative Investment Analyst® Program. He authored Private Equity Unchained (by Palgrave MacMillan).