Rebalancing Against Unfunded Commitments
An endowment has $180M and a policy of 55% global equity, 25% private capital/real assets and 20% fixed income and cash, with ±5 percentage-point bands. Current values: equity $113.4M, private capital $39.6M, fixed income $27.0M. The fund has $22M of unfunded private capital commitments to be drawn over the next 18 months, spends 4.5% of assets (paid quarterly), and receives no new gifts. Private valuations are marked with a one-to-two-quarter lag. The investment committee chair has circulated a memo: 'Equity is 8 points over target - instruct the custodian to sell $14.4M and rebalance fully to policy at Thursday's close.' A $3.5M draw is due in three weeks.
1. Compute the target trade and explain why the chair's $14.4M sale is the wrong rebalance.
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The arithmetic. Targets on $180M: equity $99M, private $45M, fixed income $36M. Current: $113.4M / $39.6M / $27.0M. Equity +$14.4M; private −$5.4M; fixed income −$9.0M.
Three reasons the instruction fails:
- You cannot buy $5.4M of private capital. Commitments are drawn over years, and the sleeve is underweight largely because the $22M of unfunded commitments has not been called. Buying it to target is not an available trade.
- Unfunded commitments are a future call on fixed income. Once the $22M is drawn, fixed income falls to $5.0M - 2.8% of assets, not 20%. The fund is not 9 points light in fixed income; it is closer to 17 points light.
- Lagged marks distort the denominator. Private NAVs trail by one to two quarters, so in a drawdown the equity weight rises mechanically as private marks catch down. 'Rebalance now' can be a trade against a denominator that is about to move.
The chair is solving a spreadsheet, not a liquidity problem.
2. What should actually be traded, and how much liquidity must be reserved?
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Sell $9.0M of equity (63% → 58%, inside the band) and place the proceeds, plus the next 12 months of spending, in a 0–12 month Treasury ladder explicitly earmarked as the private capital draw reserve.
- Reserve requirement: $22M of draws over 18 months + $8.1M of spending = $30.1M, against $27.0M of fixed income plus $9.0M of proceeds = $36.0M. Covered, with a $5.9M buffer.
- The $3.5M draw due in three weeks comes from the ladder, not from selling equity at whatever Thursday's close happens to be.
- The strategic fixed income sleeve stays at $27.0M (15%); the $9.0M reserve is reported separately so the committee sees it is committed, not discretionary.
- No new private commitments until committed capital (NAV $39.6M + unfunded $22.0M = $61.6M, i.e. 34.2% of assets) returns to the 25% target. The programme is over-committed by roughly $16.6M - the real finding.
Rebalance first with cash flows - spending, distributions, draws - and only then with trades, operating on corridors rather than a single Thursday's close.
3. What do you take to the committee, and what should the policy say?
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Diagnosis to present: the policy is internally inconsistent. A 25% private target cannot coexist with $22M of unfunded commitments (34.2% committed) and a 20% fixed income target that must also prefund those draws. Either the private target is wrong, the prefunding assumption is wrong, or the equity target must fall. Rebalancing to 55% today would sell $14.4M, only $9.0M of which has a purpose; the rest would be repurchased as draws are funded - round-trip cost and whipsaw with no risk benefit.
Policy changes to propose:
- Measure the private sleeve on a committed-capital basis (NAV + unfunded) and set the band on that measure.
- Adopt a liquidity policy: minimum 12 months of spending plus 12 months of expected draws in liquid assets, held in a named reserve.
- Formalize the rebalancing hierarchy - cash flows first, corridors second, full rebalance only at band breach and only in liquid sleeves.
- Disclose valuation lag quarterly and report equity weight both as reported and lag-adjusted.
Document the trades executed, the reserve balance, the decision to make no new commitments, and minutes recording that the chair's instruction was considered and modified for the reasons above. Governance failures are, in retrospect, usually documentation failures.