Managing New Subscriptions in Funds with Illiquid Holdings
Summary
The document considers how a new investor’s subscription can change portfolio weights when some holdings cannot be increased or traded. Its example starts with a portfolio containing liquid assets and an illiquid holding, then allocates the incoming cash to other assets because the illiquid position is unavailable. The resulting mix may give later investors exposure to assets with different expected returns than those held by earlier investors, creating a potential fairness issue.
The response suggests checking whether the new allocation complies with the fund’s prospectus, especially any minimum allocation to the illiquid asset. If existing units cannot be traded, one option is to buy similar instruments to preserve the target exposure; another is to launch a separate fund, though that adds administrative cost. The discussion is conceptual and offers no valuation, unitization, or investor equalization procedure. Its example also contains inconsistent asset labels and weights, so it should not be treated as a precise accounting model.
Key ideas
- New subscriptions can change exposure when a fund cannot add to its illiquid holdings.
- Later investors may benefit from assets whose expected returns differ from the existing portfolio.
- Fund documents can constrain how incoming capital is allocated.
- Similar instruments may help maintain exposure when the original illiquid holding cannot be purchased.
- Separate funds can address some constraints but increase management overhead.
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Full text
# How do funds with illiquid assets add new investment to their funds? # How do funds with illiquid assets add new investment to their funds? As far as I know if you have for example 40% AAA, 40% BBB, 20% CCC with a total of 100k value. And someone new comes and adds 100k you can reallocate their money to fit the 40-40-20 (same as your old portfolio) and they will own 50% of your whole portfolio which is now 200k. But what if your main portfolio has illiquid assets? This means that you'll have 40% AAA, 40% BBB, 20% XXX (illiquid, won't be traded for a few years) with a total of 100k value. Someone new comes and adds 100k to your portfolio and you do the same for 40% AAA, 40% BBB but can not buy more of XXX so you just buy 20% BBB instead. Overall your portfolio becomes 40% AAA, 50% BBB, 10% DDD and the old & new person owns 50% of the 200k portfolio. But your calculations have shown that DDD will probably increase much more than AAA & BBB, so overall, the late investors takes opportunity from the earlier investors. This problem can be solved by creating a different fund for each time a fund enters an illiquid asset but then when you scale, you'll have 100 people invested with 35 different funds to manage. How can this problem be solved? What is the best way to manage such funds? ## Answer by Peter (score 1) https://quant.stackexchange.com/a/38462 Yes, the new investor could have a opportunity. This is "normal" life. Launching a new fund is a possible way, but it is expensive (as you indicated). Sometimes it is necessary to launch a new fund: when fund restrictions are in place. Example: In your question, the investment of the new investor will shift the asset allocations from 40% (AAA), 40% (BBB), 20% (CCC) to 40% (AAA), 50% (BBB) and 10% (CCC). You have to consider if the new allocations does fit to the fund prospectus guidelines. When fund is restricted to have at least 20% in CCC (i.e. minimum investment allocation), then you have to consider two ways: a) Launch a new fund b) When existing CCC instruments are not liquid, invest in other instruments that are similar to existing CCC instruments. This will maintain existing asset allocation at 20%.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.