Conventional investing wisdom suggests investing across multiple asset classes for diversification benefits and managing liquidity needs. Disciplined asset allocation also ensures operational efficiency at the fund-level.
As a general partner (GP), you must balance opposing objectives, such as maximizing capital deployment and creation of reserves for operational expenses and strategic reinvestments. This requires you to manage private equity or venture capital investments along with money market investments and cash reserves.
Overcommitting to private equity investments makes it challenging to manage operational expenses. On the other hand, being too conservative and maintaining excessive reserves significantly reduces the fund’s potential returns.
Assets held by funds: Impact on ROI and cash flow
PE and VC funds typically invest across the following asset classes:
Private equity
Private equity has the potential to deliver outsized returns through leveraged deals or by enabling access to high-growth startups. At the same time, this asset class has some of the longest investment horizons, especially if you invest in the venture capital subset.
Private credit
Private credit comes with fixed maturity dates and interest payments, making it less risky than equity investments. The cash flow generated through interest payments can either be reinvested or repurposed for operational expenses.
For instance, suppose your fund has a 2% annual management fee. Then, allocating 20% of the capital raised to private credit allows you to account for the annual fee without creating dedicated cash reserves, even if the interest rate is a conservative 10%.
For context, if you invest in private credit markets of countries like India, you can stand to earn interest of up to 22%. But, of course, if you consider overseas investments, you must account for the country’s risk premium.
Complex securities
Sometimes, instead of directly buying equity in a company, PE and VC funds may acquire complex securities such as convertible bonds, warrants, and Simple Agreements for Future Equity (SAFE). If used correctly, such securities can help funds manage their risk exposure and maximize ROIs.
However, complex securities are comparatively less liquid and more opaque than private equity. Also, complex security investments require GPs to actively monitor existing investments, distracting them from deal-sourcing. Hence, PE funds should be careful not to overload their portfolio with complex securities.
Money market instruments
Money market instruments’ high liquidity and low risk comfortably outweigh the disadvantage of low returns, making them a viable substitute for pure cash reserves that do not attract any returns. A GP’s ability to maintain the right mix of money market instruments and private credit determines the fund’s operational efficiency and overall capital deployment.
Cash reserves
If GPs do not want the hassle of managing money market instruments or if a key opportunity is expected to open up in the near term, they may maintain some cash reserves. The purpose of these reserves is to meet operational expenses or strategic reinvestment needs.
Comparative overview of fund asset classes
The following table summarizes the key characteristics of each asset class to help you understand their role in your fund’s portfolio:
| Criteria | Private equity | Private credit | Complex securities | Money market investments | Cash |
|---|---|---|---|---|---|
| Expected returns | High | Medium | High | Low | None |
| Liquidity | Low | Medium | Low | High | Maximum |
| Risk level | High | Medium | Medium or high (varies case by case) | Low | None |
| Time commitment | High | Medium | High | Low | None |
| Role in the fund | Core return driver expected to generate the highest returns through equity appreciation | Steady cash flow generator providing predictable interest payments to manage liquidity needs | Strategic tool to optimize returns and risk exposure from otherwise excluded targets | Liquidity buffer providing minimal returns while meeting immediate expense obligations | Reserve for immediate expenses or near-term strategic opportunities requiring rapid deployment |
Fund-level asset allocation strategies
The optimal asset allocation for your fund depends on its investment thesis, stage focus, and anticipated capital call schedule. Here are 3 common fund-level asset allocation strategies:
Aggressive allocation
Here, the GPs prioritize maximizing capital deployment into high-return assets. The trade-off for high capital deployment is reduced flexibility to capitalize on unexpected opportunities or to manage unexpected expenses.
Allocating 80-90% of committed capital to private equity and complex securities, 5-10% to private credit, and the rest to money market instruments or cash reserves would be an aggressive, growth-focused asset allocation strategy.
You cannot execute this strategy unless your limited partners are extremely patient, which is typically the case in early-stage VC funds.
Balanced allocation
Allocating 65-75% of committed capital to private equity, 15-20% to private credit, 5-10% to complex securities, and 5-10% to money market instruments and cash may be considered a balanced asset allocation. The private credit allocation generates steady interest income that can comfortably offset management fees and administrative costs.
This strategy suits growth equity funds or later-stage VC funds that need predictable cash flows to manage operational expenses while still pursuing attractive equity opportunities.
Conservative allocation
A conservative fund may allocate 50-60% of the committed capital to private equity, 25-30% to private credit, 5% to complex securities, and 10-15% to money market instruments and cash. The high allocation to income-generating and liquid assets provides maximum operational flexibility.
This approach is appropriate for funds operating in uncertain market conditions, funds with shorter investment periods, or mature funds whose priorities have shifted from growth to capital preservation.
Allocation strategy example
Suppose you raised $100 million for a fund with a 2% annual management fee and a 10-year fund life. Under a balanced allocation strategy, you might structure your portfolio as follows:
- Private equity: $70 million
- Private credit: $18 million (earning 12% annually = $2.16 million)
- Complex securities: $7 million
- Money market instruments: $5 million (earning 4% annually = $200,000)
Your annual management fee would be $2 million. The combined income from private credit and money market instruments ($2.36 million) more than covers this obligation, allowing you to deploy capital aggressively into private equity while maintaining operational independence.
Eqvista- Streamlined fund operations for strategic execution!
No matter which strategy you choose, your asset allocation will not and should not remain static throughout the fund’s life. Once you reach the optimum capital deployment levels, you can think of deploying the remaining reserves to private credit and money market investments to capture additional returns.
Executing such complex strategic reallocations is next to impossible without a reliable equity management platform like Eqvista. Our platform simplifies performance tracking by linking cap tables with 409A valuations and offers valuable tools for dilution analysis and exit modelling.
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