I am pleased to be a speaker at the upcoming Emerging Manager Connect West conference being held on Tuesday, May 1, 2018 at the Marines Memorial Club in San Francisco . I will be speaking on the panel "Roadshow 101: Leading Emerging Manager Investors Discuss the Dos and Dont's for Successful LP Meetings." Here's a link to the conference website:
The denominator effect refers to an investor's private equity portfolio value exceeding its target allocation due to the decline in value of other elements in the investor's overall investment portfolio. Conversely, the “reverse denominator effect” refers to private equity value falling below its target allocation due to the increase in value of other elements in the portfolio.
In order to understand Denominator Effect and the Reverse Denominator Effect, this post will first review basic portfolio allocation and rebalancing, and then will briefly review fractions.
Portfolio Allocations and Rebalancing
Most investors will develop a portfolio investment strategy by allocating a portion of the portfolio to different investment classes (called “asset classes”) such as public equities (stocks), fixed income securities (bonds), real estate, cash and private equity. Investors may define asset classes differently and may allocate their portfolio across asset classes differently.
Let’s say an investor has $1 billion to invest. After working with their investment advisor, they have decided to create target allocations for their portfolio as follows: 40% to public equities, 40% to fixed income and 20% to private equity. (We’re keeping it simple here; most investors will allocate to more than 3 asset classes). These are target allocations – the actual values may vary from the target value.
The target allocation will look like this:
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