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FRM Part II · FRM Exam Part II · Illiquid Assets

A university endowment holds 40% of its portfolio in private equity and real estate funds that can be sold only at a large discount or after long delays. The investment committee wants to reduce the risk that the endowment is forced to sell these holdings at distressed prices to meet spending needs. Which action best addresses this risk?

Holding a buffer of liquid assets sized to cover stressed spending and unfunded commitments best reduces the risk of forced sales. The buffer provides cash without selling illiquid holdings at distressed prices, whereas longer lock-ups, smoothed valuations, or reliance on secondary markets do not solve the liquidity need.

  1. AMaintain a buffer of liquid assets sized to cover projected spending and unfunded capital commitments under stressCorrect
  2. BIncrease the allocation to funds with the longest lock-up periods to earn a higher illiquidity premium
  3. CValue the private holdings using smoothed appraisals to reduce reported volatility
  4. DRely on the secondary market as the primary source of cash for spending needs

Explanation

A liquidity buffer sized to stressed spending and unfunded commitments avoids forced sales. Longer lock-ups raise rather than reduce liquidity risk. Smoothed appraisals only mask volatility and do not create cash. Secondary markets are unreliable in stress and sell at deep discounts.

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