I guess just be aware of this… it’s tripped me up on a couple of questions. Jill Tillman, CFA, has a client who wishes to invest in private equity. The client’s total portfolio is $80 million. The client wants to invest $10 million in private equity, wants to keep the money invested for 7-10 years, and does not need liquidity. Tillman should: A) not invest the money because it represents too much of the client’s portfolio. B) invest the client’s money because private equity has the desired properties. C) not invest the money because private equity requires a longer holding period than specified by the client. Your answer: B was incorrect. The correct answer was A) not invest the money because it represents too much of the client’s portfolio. Private equity has low liquidity. The allocation to this class should be 5% or less with a plan to keep the money invested for 7-10 years. Since the client only has $80 million, the $10 million (12.5%) requested investment is too large.
Thanks Dwight. Where is this question from? Because I could not find something in the CFAI material that would support this (that you should never invest more than 5% in private equity). Actually I am quite curious about this; even 12.5% does not seem too high for me: Would you suggest that 12.5% in, say, foreign medium-long term corporate bonds (which could be similarly illiquid) would also not be appropriate?
I just did that question today too. I also chose B. It’s from the asset allocation study session test. Is the 5% rule stated in the text? It seems like there is so much subjectivity to these questions.
I’m just in the middle of this section now. In SS13, CFAI page 43 under Roles in the Portfolio, is says the following: “Private equity probably can play a moderate role as a risk diversifier. However, many investors look to private equity investment for long term return enhancement. Given the capacity issues already mentioned and private equity’s generally high illiquidity, target allocations of 5% or less are commonplace…” Whether or not that should be interpreted as a rule is anybody’s guess.
old_akakaraka Wrote: ------------------------------------------------------- > Thanks Dwight. > > Where is this question from? Because I could not > find something in the CFAI material that would > support this (that you should never invest more > than 5% in private equity). Actually I am quite > curious about this; even 12.5% does not seem too > high for me: Would you suggest that 12.5% in, say, > foreign medium-long term corporate bonds (which > could be similarly illiquid) would also not be > appropriate? Yeah I would think the same as you. It’s from a randomly generated Schweser exam, so probably meaningless.
In one of the end of chapter qns (can’t remember just now) it asks you to come up with a proposed portfolio for a foundation. I was gunning for 15% private equity given the long timeframe, above average risk toleranc, and high returns of the private equity, but the answer allocates only 5%. That seems to be a safe answer to stick with. I also notice that the CFAI text questions always favour well diversified portfolios, so the 5% upper limit seems like a safe rule of thumb to take into the exam.
yeah, i dont think that the CFAI would frame that question the same way (5% is an absolute). if it was a CFAI question, i would think that there would be more info in the question (like maybe a possible liquidity need in 3 years, etc.) that would tip you off. i am generally very wary of ‘always’ type of questions. surely there could be a situation where someone allocated 10% to PE. what if they were a PE fund manager? wouldn’t human and financial capital be more than 10%?? its not hard to see how the question could have been framed in a risk ability != willingness context, a setup which i think is more likely.