FRM Part II · FRM Exam Part II · Illiquid Assets
A portfolio manager is considering raising the allocation to illiquid assets to capture the liquidity premium. Which consideration is most appropriate when deciding the size of the allocation?
The allocation should reflect the investor's ability to bear illiquidity, considering liabilities, spending needs and funding access in stress. Smoothed Sharpe ratios are misleading, exits at NAV are not guaranteed, and the liquidity premium varies across market conditions.
- AThe investor's ability to bear illiquidity, given its liabilities, spending needs and funding sources in stressCorrect
- BReported Sharpe ratios of illiquid funds, which are reliable because of low reported volatility
- CThe expectation that illiquid assets can be sold at NAV whenever needed
- DThe fact that illiquidity premium is constant across all market conditions
Explanation
Capacity to bear illiquidity depends on liabilities, spending needs and access to funding when markets are stressed. Reported Sharpe ratios are inflated by smoothing, NAV exits are not assured, and the premium varies over time.
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