The Illiquid Allocation
A discretionary manager runs a £50 million balanced portfolio for a charity with a 6% annual spending requirement. To boost returns, the manager proposes allocating 20% (£10 million) to a private credit fund with a 7-year lock-up, quarterly capital calls, and a 1.5% management fee plus 15% performance fee. The charity's investment policy statement caps illiquid assets at 10% and requires sufficient liquidity to fund two years of spending. Current liquid reserves are £1.5 million. Markets are volatile and the manager expects redemptions from other clients. The trustee board is split; the chair favours the higher yield.
1. Evaluate the proposal against the IPS and the charity's liquidity needs.
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The proposal breaches the IPS's 10% illiquid cap (20% proposed) and the two-year spending reserve requirement. Annual spending is 6% of £50m = £3m, so two years needs £6m of liquid assets; current reserves are only £1.5m. Committing £10m to a 7-year lock-up with capital calls would leave the portfolio unable to meet spending without forced sales of other assets, potentially at depressed prices. The performance fee also reduces net return and aligns poorly with a 7-year horizon. The manager should be asked to justify any breach formally and the trustees should treat the IPS as binding unless formally amended.
2. Recommend a compliant alternative and the governance steps the trustees should take.
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Cap illiquid exposure at the 10% limit (£5m) only after building a liquidity buffer to at least £6m (two years' spending), funded from cash and short-dated bonds. Phase commitments over several years to reduce capital-call timing risk, and stress-test for a 20% drawdown plus spending. Review fees and negotiate or decline. Governance: obtain independent advice, minute the decision and rationale, record the manager's conflict (fee incentive), and set a review trigger if liquid reserves fall below the buffer. If the chair still favours more, require a formal IPS amendment with documented justification.